Want to retire early? Focus on this figure

Paul Summers outlines why a company’s ability to grow from the capital it invests can be more important than its valuation.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

A calculator, a sheet of numbers and a pen

CC0 Public Domain

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Unless you’re of an entrepreneurial bent or earn a footballer’s salary, spending less and saving more is vital if you dream of retiring early. The earlier in your life you can cultivate this habit, the better.

That said, cutting back and throwing what cash remains at the end of each month into a tax-efficient stocks and shares ISA will only go so far. If you really want to quit the rat race early, you’re going to need your investments to seriously perform over a long period of time. Here’s one way of finding companies that might do just that.

A measure of quality

Thanks to its ability to concisely indicate a company’s profitability and general health, return on capital employed (ROCE) is arguably one of the most important metrics to look at when scrutinising a prospective investment. What’s more, you don’t need a degree in finance to calculate it.

Should you invest £1,000 in N Brown Group Plc right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if N Brown Group Plc made the list?

See the 6 stocks

First, get hold of a company’s latest set of results and find the profit figure — otherwise known as earnings before interest and tax (EBIT). This is the ‘return’ part of the equation. Then find the company’s current liabilities and subtract these from its total assets. What remains is the ‘capital employed’. Now divide the first number by the second. The result is a company’s ROCE for that period. So, if Company X generates £50m of profits from capital of £200m, the ROCE is 25% (50/200 x 100).  

Companies with high ROCE (like the example above) are those that require relatively little investment to generate profits. As a result, these businesses tend to finance their own growth, reducing the need to carry debt. If they can compound returns of 25% or more over many years, the results can be life-changing for their investors, regardless of how much they paid for the shares in the first place. 

Some companies, by their very nature, score low on ROCE. Utilities, for example, require huge levels of capital to grow only a small amount. National Grid and SSE achieved ROCE figures of 8%  and 5.3% respectively in 2016. Banks are also notoriously capital-intensive with giants like Lloyds and HSBC having achieved pitifully low returns for many years. While this doesn’t automatically make these companies bad investments, their inability to grow at a fast pace means they’re unlikely to bring your retirement date forward.  

Now for something completely different

Contrast this with companies like retailer JD Sports and property portal Rightmove, both of which have managed to generate superb returns on a consistent basis. With ROCE averaging around 25% over the last five years, shares in the former have nine-bagged since February 2012. Continuous reinvestment has also allowed the latter to grow rapidly and become the go-to destination for house buyers. Today, shares in Rightmove exchange hands for over eight times their price in 2007. That’s despite rarely straying from a relatively high valuation. This highlights how fixating on a company’s price-to-earnings (P/E) ratio rather than its ability to reinvest and compound returns can actually be detrimental to your wealth. Sometimes, you really do get what you pay for. 

So, before making your next share purchase, take a look at how the company fares on this measure. Fill your portfolio with businesses that generate high margins from relatively little investment and your dreams of early retirement might be realised sooner than you think. 

Should you invest £1,000 in N Brown Group Plc right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets.

And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if N Brown Group Plc made the list?

See the 6 stocks

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings and Rightmove. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Up 20% in a month, should investors consider buying Marks & Spencer shares?

Shares in retailer Marks and Spencer have surged ahead over the last month, despite a cyberattack. Roland Head takes a…

Read more »

Charticle

Here are the latest growth and share price targets for Nvidia stock

Ben McPoland checks out the latest forecasts for Nvidia stock to assess whether it might be worth considering for a…

Read more »

Growth Shares

Yikes! This could be the most undervalued growth stock in the FTSE 100

Jon Smith flags up a growth stock with a low price-to-earnings ratio and a share price back at 2020 levels…

Read more »

Abstract bull climbing indicators on stock chart
Investing Articles

3 beaten-down FTSE 250 shares to consider buying before the next bull market

Paul Summers thinks brave investors should ponder buying some of the FTSE 250s poor performers before they recover strongly.

Read more »

Investing Articles

Gold prices soar while the Fresnillo share price slumps. What gives?

With a gold bull market in full swing, this Fool argues that the falling Fresnillo share price may not remain…

Read more »

Investing Articles

2 FTSE 100 shares I’m avoiding like the plague right now

While the FTSE remains packed with opportunity, many of the index's blue-chip shares could be at risk as trade tariffs…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

Here’s how an investor could aim for a million buying under 10 shares

Christopher Ruane explains why doing less, not more, of the right things could be the key to success as an…

Read more »

Investing Articles

Could this new risk cause a stock market crash?

Tariffs and a potential recession are two major stock market risks right now. But there’s another risk that concerns Edward…

Read more »