U.S. markets open in 1 hour 10 minutes
  • S&P Futures

    3,273.50
    -1.50 (-0.05%)
     
  • Dow Futures

    26,982.00
    -73.00 (-0.27%)
     
  • Nasdaq Futures

    11,019.00
    +30.00 (+0.27%)
     
  • Russell 2000 Futures

    1,479.40
    -3.40 (-0.23%)
     
  • Crude Oil

    39.35
    +0.04 (+0.10%)
     
  • Gold

    1,911.60
    +1.00 (+0.05%)
     
  • Silver

    24.25
    -0.13 (-0.54%)
     
  • EUR/USD

    1.1740
    -0.0033 (-0.28%)
     
  • 10-Yr Bond

    0.6710
    0.0000 (0.00%)
     
  • Vix

    27.87
    +2.04 (+7.90%)
     
  • GBP/USD

    1.2793
    -0.0024 (-0.19%)
     
  • USD/JPY

    104.5730
    -0.1070 (-0.10%)
     
  • BTC-USD

    10,465.68
    +27.95 (+0.27%)
     
  • CMC Crypto 200

    221.61
    -13.97 (-5.93%)
     
  • FTSE 100

    5,820.16
    +15.87 (+0.27%)
     
  • Nikkei 225

    23,360.30
    +40.90 (+0.18%)
     

Does WPP's (LON:WPP) Returns On Capital Reflect Well On The Business?

Simply Wall St

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within WPP (LON:WPP), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for WPP:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.082 = UK£1.3b ÷ (UK£31b - UK£16b) (Based on the trailing twelve months to December 2019).

Thus, WPP has an ROCE of 8.2%. On its own, that's a low figure but it's around the 8.9% average generated by the Media industry.

Check out our latest analysis for WPP

roce
roce

In the above chart we have a measured WPP's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering WPP here for free.

How Are Returns Trending?

There is reason to be cautious about WPP, given the returns are trending downwards. About five years ago, returns on capital were 12%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect WPP to turn into a multi-bagger.

On a separate but related note, it's important to know that WPP has a current liabilities to total assets ratio of 50%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From WPP's ROCE

In summary, it's unfortunate that WPP is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 45% over the last five years, so it looks like investors are recognizing these changes. Unless these trends revert to a more positive trajectory, we would look elsewhere.

WPP does have some risks though, and we've spotted 2 warning signs for WPP that you might be interested in.

While WPP may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.