After reading over Bell Canada’s (BCE) latest annual report, one thing became painfully obvious: the company is becoming less efficient.

Bell Canada is often thought of as a dividend stock. The company’s annual yield is just shy of 6% and a lot of people purchase the stock for its income. The company doesn’t distribute all of its earnings to shareholders and what’s left gets put in the company’s coffers, thereby increasing the amount of invested capital.

Companies that can achieve good returns on invested capital are hard to find. At BCE, however, that capital is becoming less efficient as it increases.

In 2006 the company had revenue of $17.6 billion on invested capital of ~$23 billion*. Put another way, in 2006 BCE required $1.33 in invested capital to generate $1.00 of revenue. In 2009, the company generated revenue of $17.7 billion on invested capital of ~$27.2 billion. That means that in order to generate $1 of revenue BCE now requires a capital investment of $1.55.

One question investors might want to ask themselves is whether Bell Canada can continue to earn a net profit margin of >18-22% or if this number is artificially high. If the company can earn 18% on $1 of revenue, shareholders receive a return on invested capital of $0.18/$1.55= 11.6% (good, but not great). If, however, competition, regulatory or other factors lower that net profit margin to, say, 2008 levels (of around 11.4%), investors a return of only 7% on invested capital.

Over the last 3 years, BCE has invested ~$3.7 billion of shareholder money back into the business. Over this same period, the company has increased sales by less than $100 million. The recent growth in ‘profits’ has all come from profit margin expansion (which can’t go on expanding forever).

* “Invested capital” is understated with our simple calculation.