Be Wary Of SHW (HMSE:SW10) And Its Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating SHW (HMSE:SW10), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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. Analysts use this formula to calculate it for SHW:

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

0.043 = €11m ÷ (€376m - €119m) (Based on the trailing twelve months to December 2023).

So, SHW has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 8.6%.

Check out our latest analysis for SHW

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of SHW.

The Trend Of ROCE

In terms of SHW's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 7.4%, but since then they've fallen to 4.3%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that SHW is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 34% over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One final note, you should learn about the 4 warning signs we've spotted with SHW (including 2 which don't sit too well with us) .

While SHW isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.