What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Compumedics (ASX:CMP) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is Return On Capital Employed (ROCE)?
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 Compumedics:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.041 = AU$940k ÷ (AU$36m - AU$13m) (Based on the trailing twelve months to December 2020).
Therefore, Compumedics has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 8.8%.
Above you can see how the current ROCE for Compumedics 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 Compumedics here for free.
What Can We Tell From Compumedics' ROCE Trend?
In terms of Compumedics' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 23% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
What We Can Learn From Compumedics' ROCE
We're a bit apprehensive about Compumedics because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 12% 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.
Compumedics does have some risks though, and we've spotted 2 warning signs for Compumedics that you might be interested in.
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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