A profit ratio that’s often overlooked by investors is return on capital employed. Put simply, this measures how much profit is made, relative to the money that’s tied up in the business.
History suggests that investing in companies with a high return on capital employed (ROCE) can be a profitable strategy. These firms can usually fund their own growth and often provide attractive dividends. For this reason, I’ve been looking at two high ROCE stocks in the consumer sector.
High enough for now?
Online fashion retailer Boohoo.Com (LSE: BOO) needs little introduction. The Manchester-based group’s meteoric growth has caused the shares to triple over the last three years.
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But while sales and profits are still rising fast, the group’s share price has been falling. Boohoo stock has now fallen by 42% from its 52-week high of 329p.
This decline isn’t due to poor financial performance. ROCE rose from 20% to 26% last year, as profits doubled following investment in new facilities. That’s well above my rule-of-thumb minimum ROCE of 15% for high quality businesses.
This could be the problem
I see this as a great business. But with a market cap of £2.1bn, it’s now quite large. Earnings per share are only expected to rise by about 30% this year, compared to a five-year average rate of well over 100% per year.
This has left the stock looking quite pricey. Based on analysts’ consensus forecasts for earnings of 2.8p per share this year, the stock has a forecast P/E of 65 for 2017/18, with a PEG ratio of 2.3 — a long way from value territory.
I suspect these shares may have further to fall before resuming their growth trajectory. If I owned this stock, I’d consider shifting some cash into one with stronger value credentials.
An overlooked gem?
One company I may add to my portfolio is toy maker Character Group (LSE: CCT). This £90m firm has been hit by the fallout from the collapse of Toys-R-Us, but today’s full-year results suggest to me that the damage will be limited.
Full-year revenue fell by 4.7% to £115.3m, but pre-tax profit excluding currency effects rose by 6.9% to £13.4m. Underlying earnings were up 12% to 50.5p per share, while the group’s net cash balance climbed 67% to £11.5m.
Management admits that weaker-than-expected orders from international customers will hit sales over Christmas. In order to limit the damage, inventories have been kept at a lower level than usual. The business is expected to return to growth during the second half of next year.
Despite these efforts, Character’s profitability has suffered. My calculations indicate that ROCE has fallen from 57.7% in 2016 to 46.2% in 2017. That’s disappointing, but I think it needs to be kept in context — 46% is still very high.
Why I might buy
To reward loyal shareholders, the full-year dividend for 2016/17 has been increased by 26.7% to 19p. At the current share price of around 420p, this gives a dividend yield of 4.5%. With the shares currently trading on a forecast P/E of 10 for 2017/18, I think this business could be too cheap to ignore.
I’ve added Character Group to my watch list for further research. Although 2018 could be a difficult year, I believe this remains an attractive business.
