The Returns On Capital At Sigma Healthcare (ASX:SIG) 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? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. 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 Sigma Healthcare (ASX:SIG) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

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

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

0.05 = AU$34m ÷ (AU$1.2b - AU$524m) (Based on the trailing twelve months to January 2021).

So, Sigma Healthcare has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 11%.

Check out our latest analysis for Sigma Healthcare

Above you can see how the current ROCE for Sigma Healthcare compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Sigma Healthcare's ROCE Trend?

When we looked at the ROCE trend at Sigma Healthcare, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.0% from 16% five years ago. However it looks like Sigma Healthcare 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, Sigma Healthcare's current liabilities are still rather high at 43% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Sigma Healthcare's ROCE

Bringing it all together, while we're somewhat encouraged by Sigma Healthcare's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 38% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

If you'd like to know about the risks facing Sigma Healthcare, we've discovered 1 warning sign that you should be aware of.

While Sigma Healthcare 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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