Yellow Cake (LON:YCA) Could Be Struggling To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Having said that, from a first glance at Yellow Cake (LON:YCA) 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. To calculate this metric for Yellow Cake, this is the formula:

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

0.073 = US$31m ÷ (US$428m - US$7.0m) (Based on the trailing twelve months to March 2021).

Thus, Yellow Cake has an ROCE of 7.3%. Ultimately, that's a low return and it under-performs the Trade Distributors industry average of 13%.

See our latest analysis for Yellow Cake

roce

In the above chart we have measured Yellow Cake's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Yellow Cake's ROCE Trend?

In terms of Yellow Cake's historical ROCE movements, the trend isn't fantastic. Over the last two years, returns on capital have decreased to 7.3% from 12% two years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

In Conclusion...

While returns have fallen for Yellow Cake in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 42% to shareholders over the last three years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you want to know some of the risks facing Yellow Cake we've found 2 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.

While Yellow Cake 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. 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.

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