When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at PPL (NYSE:PPL), so let's see why.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on PPL is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.042 = US$1.4b ÷ (US$38b - US$3.8b) (Based on the trailing twelve months to December 2022).
Therefore, PPL has an ROCE of 4.2%. In absolute terms, that's a low return but it's around the Electric Utilities industry average of 4.7%.
In the above chart we have measured PPL's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for PPL.
What Can We Tell From PPL's ROCE Trend?
There is reason to be cautious about PPL, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 8.2% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on PPL becoming one if things continue as they have.
Our Take On PPL's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors must expect better things on the horizon though because the stock has risen 23% in the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
Like most companies, PPL does come with some risks, and we've found 2 warning signs that you should be aware of.
While PPL isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
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