Finding a business that has the potential to grow significantly isn’t easy, but it is possible if we take a look at a few key financial metrics. Ideally, a business will display two trends; first growth return on capital employed (ROCE) and on the other hand, an increase amount capital employed. Put simply, these types of businesses are dialing machines, which means they continually reinvest their profits at ever higher rates of return. With that in mind, we have noticed some promising trends at TPG Telecom (ASX: TPG) so let’s look a little deeper.
Understanding Return on Capital Employed (ROCE)
Just to clarify if you’re not sure, ROCE is a measure of the pre-tax income (as a percentage) that a business earns on the capital invested in its business. Analysts use this formula to calculate it for TPG Telecom:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.014 = A $ 237 million ÷ (A $ 19 billion – A $ 1.5 billion) (Based on the last twelve months up to December 2020).
So, TPG Telecom posted a ROCE of 1.4%. In absolute terms, this is a low return and it is also below the telecom industry average of 5.4%.
See our latest review for TPG Telecom
In the graph above, we measured TPG Telecom’s past ROCE against its past performance, but the future is arguably more important. If you’d like to see what analysts are forecasting for the future, you should check out our free report for TPG Telecom.
How are the returns evolving?
We are delighted to see that TPG Telecom is reaping the rewards of its investments and is now generating pre-tax profits. The company was making losses five years ago, but now it’s gaining 1.4%, which is a sight to behold. On top of that, TPG Telecom employs 256% more capital than before, which is expected of a company trying to break into profitability. This may tell us that the company has many reinvestment opportunities capable of generating higher returns.
On a related note, the ratio of the company’s current liabilities to total assets declined to 7.7%, fundamentally reducing its funding from short-term creditors or suppliers. So this improvement in ROCE came from the underlying economics of the business, which is great to see.
To the delight of most shareholders, TPG Telecom has now returned to profitability. Given that the stock has fallen 29% in the past year, this could be a good investment if valuation and other metrics are attractive as well. With that in mind, we believe the promising trends warrant further investigation of this stock.
Since virtually every business faces risks, it’s worth knowing about them, and we’ve spotted 2 warning signs for TPG Telecom (1 of which is of concern!) that you should know about.
While TPG Telecom does not currently achieve the highest returns, we have compiled a list of companies that currently generate over 25% return on equity. Check it out free list here.
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