Yahoo Finance Here's What's Concerning About SThree's (LON:STEM) Returns On Capital
To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So while SThree (LON:STEM) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Return On Capital Employed (ROCE): What Is It?
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 SThree is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.32 = UK£78m ÷ (UK£472m - UK£230m) (Based on the trailing twelve months to November 2023).
So, SThree has an ROCE of 32%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 18%.
Check out our latest analysis for SThree
Above you can see how the current ROCE for SThree compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for SThree .
What Does the ROCE Trend For SThree Tell Us?
In terms of SThree's historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 52% where it was five years ago. However it looks like SThree might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a side note, SThree has done well to pay down its current liabilities to 49% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 49% is still pretty high, so those risks are still somewhat prevalent.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by SThree's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 78% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you'd like to know about the risks facing SThree, we've discovered 1 warning sign that you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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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