CAP (SNSE:CAP) Knows How To Allocate Capital Effectively

Simply Wall St
January 14, 2022
Source: Shutterstock

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. And in light of that, the trends we're seeing at CAP's (SNSE:CAP) look very promising so lets take a look.

What is Return On Capital Employed (ROCE)?

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. To calculate this metric for CAP, this is the formula:

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

0.33 = US$1.6b ÷ (US$6.3b - US$1.5b) (Based on the trailing twelve months to September 2021).

Thus, CAP has an ROCE of 33%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 23%.

See our latest analysis for CAP

SNSE:CAP Return on Capital Employed January 14th 2022

In the above chart we have measured CAP's prior ROCE against its prior performance, but the future is arguably more important. 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 CAP Tell Us?

CAP is showing promise given that its ROCE is trending up and to the right. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 1,442% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 24% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

What We Can Learn From CAP's ROCE

To bring it all together, CAP has done well to increase the returns it's generating from its capital employed. Since the stock has returned a staggering 117% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

One more thing: We've identified 3 warning signs with CAP (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

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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