Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, while the ROCE is currently high for SThree (LON:STEM), we aren't jumping out of our chairs because returns are decreasing.
What Is Return On Capital Employed (ROCE)?
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. To calculate this metric for SThree, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.34 = UK£78m ÷ (UK£470m - UK£244m) (Based on the trailing twelve months to November 2022).
So, SThree has an ROCE of 34%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 15%.
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'd like, you can check out the forecasts from the analysts covering SThree here for free.
What The Trend Of ROCE Can 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 54% where it was five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, SThree has done well to pay down its current liabilities to 52% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 52% is still pretty high, so those risks are still somewhat prevalent.
Our Take On SThree's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that SThree is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 43% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.
On a separate note, we've found 1 warning sign for SThree you'll probably want to know about.
SThree is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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