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Here's What's Concerning About Royal Mail's (LON:RMG) Returns On Capital

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·3-min read
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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Royal Mail (LON:RMG) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Royal Mail is:

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

0.06 = UK£433m ÷ (UK£9.9b - UK£2.6b) (Based on the trailing twelve months to September 2020).

Therefore, Royal Mail has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Logistics industry average of 9.1%.

View our latest analysis for Royal Mail

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Above you can see how the current ROCE for Royal Mail 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 Royal Mail here for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Royal Mail doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.0% from 13% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

The Bottom Line On Royal Mail's ROCE

To conclude, we've found that Royal Mail is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 29% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

If you want to continue researching Royal Mail, you might be interested to know about the 3 warning signs that our analysis has discovered.

While Royal Mail isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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 (at) simplywallst.com.