SGS (VTX:SGSN) Has Some Way To Go To Become A Multi-Bagger

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Looking at SGS (VTX:SGSN), it does have a high ROCE right now, but lets see how returns are trending.

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

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. Analysts use this formula to calculate it for SGS:

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

0.24 = CHF963m ÷ (CHF6.8b - CHF2.7b) (Based on the trailing twelve months to June 2022).

Therefore, SGS has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 13%.

See 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'd like, you can check out the forecasts from the analysts covering SGS here for free.

The Trend Of ROCE

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. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. Although current returns are high, we'd need more evidence of underlying growth for it to look like a multi-bagger going forward. That probably explains why SGS has been paying out 84% of its earnings as dividends to shareholders. If the company is in fact lacking growth opportunities, that's one of the viable alternatives for the money.

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 40% of total assets, this reported ROCE would probably be less than24% because total capital employed would be higher.The 24% 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.

The Bottom Line

Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. And investors may be recognizing these trends since the stock has only returned a total of 6.0% to shareholders over the last five years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

SGS does have some risks though, and we've spotted 2 warning signs for SGS that you might be interested in.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.