SEEK (ASX:SEK) May Have Issues Allocating Its Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating SEEK (ASX:SEK), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for SEEK, this is the formula:

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

0.068 = AU$227m ÷ (AU$4.6b - AU$1.3b) (Based on the trailing twelve months to June 2021).

Thus, SEEK has an ROCE of 6.8%. In absolute terms, that's a low return and it also under-performs the Interactive Media and Services industry average of 16%.

View our latest analysis for SEEK

Above you can see how the current ROCE for SEEK compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for SEEK.

So How Is SEEK's ROCE Trending?

When we looked at the ROCE trend at SEEK, we didn't gain much confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 6.8%. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 28%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 6.8%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From SEEK's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that SEEK is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 153% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing, we've spotted 2 warning signs facing SEEK that you might find interesting.

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.

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.

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