Sims (ASX:SGM) Might Be Having Difficulty Using Its Capital Effectively

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Sims (ASX:SGM) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Sims:

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

0.056 = AU$195m ÷ (AU$4.4b - AU$836m) (Based on the trailing twelve months to December 2022).

Thus, Sims has an ROCE of 5.6%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 10%.

View our latest analysis for Sims

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

SWOT Analysis for Sims

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Sims doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.6% from 7.3% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Sims is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 26% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Like most companies, Sims does come with some risks, and we've found 2 warning signs that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.