Our Take On The Returns On Capital At SDI (ASX:SDI)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think SDI (ASX:SDI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is 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. To calculate this metric for SDI, this is the formula:

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

0.066 = AU$5.1m ÷ (AU$85m - AU$7.8m) (Based on the trailing twelve months to June 2020).

Therefore, SDI has an ROCE of 6.6%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 10%.

See our latest analysis for SDI

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of SDI, check out these free graphs here.

So How Is SDI's ROCE Trending?

On the surface, the trend of ROCE at SDI doesn't inspire confidence. Around five years ago the returns on capital were 14%, but since then they've fallen to 6.6%. 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.

The Bottom Line On SDI's ROCE

In summary, we're somewhat concerned by SDI's diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 58% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

SDI does have some risks, we noticed 4 warning signs (and 1 which can't be ignored) we think you should know about.

While SDI isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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