If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. That's why when we briefly looked at Smartgroup's (ASX:SIQ) ROCE trend, we were very happy with what we saw.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Smartgroup, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = AU$71m ÷ (AU$408m - AU$102m) (Based on the trailing twelve months to December 2020).
So, Smartgroup has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 15%.
In the above chart we have measured Smartgroup'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 Smartgroup.
The Trend Of ROCE
In terms of Smartgroup's history of ROCE, it's quite impressive. The company has employed 125% more capital in the last five years, and the returns on that capital have remained stable at 23%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.
The Key Takeaway
Smartgroup has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. Therefore it's no surprise that shareholders have earned a respectable 69% return if they held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
One more thing to note, we've identified 1 warning sign with Smartgroup and understanding it should be part of your investment process.
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. 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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