Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we’d want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don’t think Flex (NASDAQ:FLEX) has the makings of a multi-bagger going forward, but let’s have a look at why that may be.
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. Analysts use this formula to calculate it for Flex:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.077 = US$564m ÷ (US$14b – US$6.8b) (Based on the trailing twelve months to June 2020).
Thus, Flex has an ROCE of 7.7%. Ultimately, that’s a low return and it under-performs the Electronic industry average of 9.8%.
Above you can see how the current ROCE for Flex 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 Flex here for free.
So How Is Flex’s ROCE Trending?
In terms of Flex’s historical ROCE movements, the trend isn’t fantastic. Over the last five years, returns on capital have decreased to 7.7% from 11% five years ago. And considering revenue has dropped while employing more capital, we’d be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven’t increased.Another thing to note, Flex has a high ratio of current liabilities to total assets of 48%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we’d like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line On Flex’s ROCE
In summary, we’re somewhat concerned by Flex’s diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 4.5% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren’t huge fans of the current trends and so with that we think you might find better investments elsewhere.
Since virtually every company faces some risks, it’s worth knowing what they are, and we’ve spotted 3 warning signs for Flex (of which 2 are a bit concerning!) that you should know about.
While Flex isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. 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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