If you’re looking at a mature business that’s past the growth phase, what are some of the underlying trends that pop up? Typically, we’ll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing 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 we looked into KAP (JSE:KAP), the trends above didn’t look too great.
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. The formula for this calculation on KAP is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.067 = R1.4b ÷ (R30b – R8.8b) (Based on the trailing twelve months to December 2023).
Therefore, KAP has an ROCE of 6.7%. In absolute terms, that’s a low return and it also under-performs the Industrials industry average of 8.8%.
Check out our latest analysis for KAP
Above you can see how the current ROCE for KAP 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 KAP for free.
What Can We Tell From KAP’s ROCE Trend?
There is reason to be cautious about KAP, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 11% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren’t as high due potentially to new competition or smaller margins. So because these trends aren’t typically conducive to creating a multi-bagger, we wouldn’t hold our breath on KAP becoming one if things continue as they have.
Our Take On KAP’s ROCE
All in all, the lower returns from the same amount of capital employed aren’t exactly signs of a compounding machine. Investors haven’t taken kindly to these developments, since the stock has declined 58% from where it was five years ago. With underlying trends that aren’t great in these areas, we’d consider looking elsewhere.
One final note, you should learn about the 3 warning signs we’ve spotted with KAP (including 1 which is a bit concerning) .
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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
