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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Travis Perkins (LON:TPK) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Travis Perkins:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.008 = UK£35m ÷ (UK£6.0b - UK£1.7b) (Based on the trailing twelve months to June 2020).
Therefore, Travis Perkins has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 12%.
View our latest analysis for Travis Perkins
In the above chart we have measured Travis Perkins' 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.
So How Is Travis Perkins' ROCE Trending?
On the surface, the trend of ROCE at Travis Perkins doesn't inspire confidence. To be more specific, ROCE has fallen from 9.9% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Bottom Line
We're a bit apprehensive about Travis Perkins because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 23% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Travis Perkins could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.