If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Having said that, while the ROCE is currently high for Smartgroup (ASX:SIQ), we aren't jumping out of our chairs because returns are decreasing.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Smartgroup:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = AU$91m ÷ (AU$418m - AU$105m) (Based on the trailing twelve months to December 2023).
Thus, Smartgroup has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 15%.
View our latest analysis for Smartgroup
Above you can see how the current ROCE for Smartgroup 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 Smartgroup .
So How Is Smartgroup's ROCE Trending?
There hasn't been much to report for Smartgroup's returns and its level of capital employed because both metrics have been steady for the past five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So it may not be a multi-bagger in the making, but given the decent 29% return on capital, it'd be difficult to find fault with the business's current operations. That probably explains why Smartgroup has been paying out 86% of its earnings as dividends to shareholders. If the company is in fact lacking growth opportunities, that's one of the viable alternatives for the money.
What We Can Learn From Smartgroup's ROCE
Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. Although the market must be expecting these trends to improve because the stock has gained 53% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Like most companies, Smartgroup does come with some risks, and we've found 1 warning sign that you should be aware of.
Smartgroup 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.
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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.
About ASX:SIQ
Very undervalued with solid track record and pays a dividend.
