The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market
and want to better understand how you can grow your money by investing in PZ Cussons Plc (LON:PZC).
Buying PZ Cussons makes you a partial owner of the company.
This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor.
Your return is tied to PZC’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment.
To understand PZ Cussons’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
ROCE: Explanation and Calculation
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio.
The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments.
To determine PZ Cussons’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc).
Take a look at the formula box beneath:
ROCE Calculation for PZC
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = UK£80m ÷ (UK£1.0b – UK£471m) = 15%
PZC’s 15% ROCE means that for every £100 you invest, the company creates £15.4.
This makes PZ Cussons satisfactorily profitable when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future and is able to either provide solid dividends or reinvestment opportunities, your capital will enlarge at a favourable rate over time.
Before moving forward
PZ Cussons’s relatively strong ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment PZ Cussons is in a favourable position, but this can change if these factors underperform.
So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving.
Looking at the past 3 year period shows us that PZC weakened investor return on capital employed from 18%.
In this time, earnings have fallen from UK£102m to UK£80m and
capital employed declined as well albeit by a relatively smaller amount, signifying ROCE decreased as a result of a greater fall in earnings compared to the business’ use of capital.
Although PZ Cussons’s ROCE has decreased over the past few years,
the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment.
It is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as
future prospects and valuation.
If you don’t pay attention to these factors
you cannot be sure if the downward path is a signal to run, or just a blip in an otherwise solid return profile.
If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate PZC or other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for PZC’s future growth? Take a look at our free research report of analyst consensus for PZC’s outlook.
- Valuation: What is PZC worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether PZC is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.