Returns On Capital At Sulzer (VTX:SUN) Have Hit The Brakes

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after briefly looking over the numbers, we don't think Sulzer (VTX:SUN) 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 Sulzer is:

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

0.08 = CHF228m ÷ (CHF5.0b - CHF2.2b) (Based on the trailing twelve months to December 2021).

Thus, Sulzer has an ROCE of 8.0%. Ultimately, that's a low return and it under-performs the Machinery industry average of 13%.

See our latest analysis for Sulzer

In the above chart we have measured Sulzer's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Sulzer.

What The Trend Of ROCE Can Tell Us

Over the past five years, Sulzer's ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. With that in mind, unless investment picks up again in the future, we wouldn't expect Sulzer to be a multi-bagger going forward. This probably explains why Sulzer is paying out 52% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 43% of total assets, this reported ROCE would probably be less than8.0% because total capital employed would be higher.The 8.0% ROCE could be even lower if current liabilities weren't 43% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

In Conclusion...

In summary, Sulzer isn't compounding its earnings but is generating stable returns on the same amount of capital employed. And with the stock having returned a mere 6.6% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

On a final note, we've found 1 warning sign for Sulzer that we think you should be aware of.

While Sulzer 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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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.