Returns On Capital At Sonic Healthcare (ASX:SHL) Have Hit The Brakes

What are the early trends we should look for to identify a stock that could 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Sonic Healthcare (ASX:SHL) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Sonic Healthcare, this is the formula:

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

0.092 = AU$1.0b ÷ (AU$13b - AU$1.9b) (Based on the trailing twelve months to June 2023).

Thus, Sonic Healthcare has an ROCE of 9.2%. In absolute terms, that's a low return, but it's much better than the Healthcare industry average of 7.5%.

See our latest analysis for Sonic Healthcare

Above you can see how the current ROCE for Sonic Healthcare 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 Sonic Healthcare here for free.

How Are Returns Trending?

In terms of Sonic Healthcare's historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 9.2% for the last five years, and the capital employed within the business has risen 52% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

Our Take On Sonic Healthcare's ROCE

As we've seen above, Sonic Healthcare's returns on capital haven't increased but it is reinvesting in the business. Since the stock has gained an impressive 65% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing to note, we've identified 1 warning sign with Sonic Healthcare and understanding this should be part of your investment process.

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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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.