The Returns On Capital At SDI (ASX:SDI) Don't Inspire Confidence

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at SDI (ASX:SDI) and its ROCE trend, we weren't exactly thrilled.

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

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. The formula for this calculation on SDI is:

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

0.088 = AU$7.0m ÷ (AU$89m - AU$9.0m) (Based on the trailing twelve months to December 2020).

Therefore, SDI has an ROCE of 8.8%. Even though it's in line with the industry average of 8.8%, it's still a low return by itself.

View 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're interested in investigating SDI's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of SDI's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 8.8% from 15% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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

We're a bit apprehensive about SDI because despite more capital being deployed in the business, returns on that capital and sales have both fallen. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 105%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing: We've identified 3 warning signs with SDI (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

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.

When trading SDI or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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