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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Telecom Plus (LON:TEP) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is 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. The formula for this calculation on Telecom Plus is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = UK£51m ÷ (UK£431m - UK£126m) (Based on the trailing twelve months to September 2020).
So, Telecom Plus has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 5.4% generated by the Integrated Utilities industry.
Above you can see how the current ROCE for Telecom Plus compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Telecom Plus here for free.
What The Trend Of ROCE Can Tell Us
Things have been pretty stable at Telecom Plus, with its capital employed and returns on that capital staying somewhat the same for the last five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect Telecom Plus to be a multi-bagger going forward. On top of that you'll notice that Telecom Plus has been paying out a large portion (105%) of earnings in the form of dividends to shareholders. If the company is in fact lacking growth opportunities, that's one of the viable alternatives for the money.
The Bottom Line
We can conclude that in regards to Telecom Plus' returns on capital employed and the trends, there isn't much change to report on. Although the market must be expecting these trends to improve because the stock has gained 65% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Like most companies, Telecom Plus does come with some risks, and we've found 1 warning sign that you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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.
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