What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we’ll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it’s a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Spirax-Sarco Engineering (LON:SPX) and its ROCE trend, we weren’t exactly thrilled.
Return On Capital Employed (ROCE): What is it?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Spirax-Sarco Engineering:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.18 = UK£254m ÷ (UK£1.7b – UK£251m) (Based on the trailing twelve months to December 2019).
So, Spirax-Sarco Engineering has an ROCE of 18%. On its own, that’s a standard return, however it’s much better than the 11% generated by the Machinery industry.
In the above chart we have a measured Spirax-Sarco Engineering’s prior ROCE against its prior performance, but the future is arguably more important. If you’d like to see what analysts are forecasting going forward, you should check out our free report for Spirax-Sarco Engineering.
What Does the ROCE Trend For Spirax-Sarco Engineering Tell Us?
On the surface, the trend of ROCE at Spirax-Sarco Engineering doesn’t inspire confidence. Over the last five years, returns on capital have decreased to 18% from 25% five years ago. Meanwhile, the business is utilizing more capital but this hasn’t moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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.
The Bottom Line On Spirax-Sarco Engineering’s ROCE
Bringing it all together, while we’re somewhat encouraged by Spirax-Sarco Engineering’s reinvestment in its own business, we’re aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 235% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn’t high.
One more thing to note, we’ve identified 3 warning signs with Spirax-Sarco Engineering and understanding these should be part of your investment process.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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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