SGS (VTX:SGSN) Has More To Do To Multiply In Value Going Forward

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. So while SGS (VTX:SGSN) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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. Analysts use this formula to calculate it for SGS:

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

0.21 = CHF906m ÷ (CHF7.1b - CHF2.9b) (Based on the trailing twelve months to December 2022).

Therefore, SGS has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 14%.

View our latest analysis for SGS

Above you can see how the current ROCE for SGS 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 Does the ROCE Trend For SGS Tell Us?

Things have been pretty stable at SGS, with its capital employed and returns on that capital staying somewhat the same for the last five years. 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. So it may not be a multi-bagger in the making, but given the decent 21% return on capital, it'd be difficult to find fault with the business's current operations. On top of that you'll notice that SGS has been paying out a large portion (79%) of earnings in the form of dividends to shareholders. These mature businesses typically have reliable earnings and not many places to reinvest them, so the next best option is to put the earnings into shareholders pockets.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 40% of total assets, this reported ROCE would probably be less than21% because total capital employed would be higher.The 21% ROCE could be even lower if current liabilities weren't 40% 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.

Our Take On SGS' ROCE

In summary, SGS isn't compounding its earnings but is generating decent returns on the same amount of capital employed. Unsurprisingly then, the total return to shareholders over the last five years has been flat. Therefore based on the analysis done in this article, we don't think SGS has the makings of a multi-bagger.

If you'd like to know about the risks facing SGS, we've discovered 2 warning signs that you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.