Returns On Capital At SAF-Holland (ETR:SFQ) Have Stalled

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. However, after briefly looking over the numbers, we don't think SAF-Holland (ETR:SFQ) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 SAF-Holland, this is the formula:

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

0.13 = €92m ÷ (€1.2b - €439m) (Based on the trailing twelve months to June 2022).

So, SAF-Holland has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Auto Components industry average of 9.6% it's much better.

Our analysis indicates that SFQ is potentially undervalued!

Above you can see how the current ROCE for SAF-Holland 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 The Trend Of ROCE Can Tell Us

There hasn't been much to report for SAF-Holland's returns and its level of capital employed because both metrics have been steady for the past 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 don't be surprised if SAF-Holland doesn't end up being a multi-bagger in a few years time. This probably explains why SAF-Holland is paying out 36% of its income to shareholders in the form of dividends. Unless businesses have highly compelling growth opportunities, they'll typically return some money to 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 38% of total assets, this reported ROCE would probably be less than13% because total capital employed would be higher.The 13% ROCE could be even lower if current liabilities weren't 38% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

The Key Takeaway

We can conclude that in regards to SAF-Holland's returns on capital employed and the trends, there isn't much change to report on. And in the last five years, the stock has given away 52% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

SAF-Holland does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those shouldn't be ignored...

While SAF-Holland may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.