Capital Allocation Trends At Simonds Group (ASX:SIO) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. So when we looked at Simonds Group (ASX:SIO), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Return On Capital Employed (ROCE): What is it?

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. Analysts use this formula to calculate it for Simonds Group:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.24 = AU$11m ÷ (AU$174m - AU$127m) (Based on the trailing twelve months to June 2021).

Therefore, Simonds Group has an ROCE of 24%. On its own that's a fantastic return on capital, though it's the same as the Consumer Durables industry average of 24%.

See our latest analysis for Simonds Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Simonds Group's ROCE against it's prior returns. If you'd like to look at how Simonds Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Simonds Group Tell Us?

When we looked at the ROCE trend at Simonds Group, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 50% where it was five years ago. However it looks like Simonds Group might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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.

On a side note, Simonds Group has done well to pay down its current liabilities to 73% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

In summary, Simonds Group is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet.

On a final note, we've found 2 warning signs for Simonds Group that we think you should be aware of.

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.