Seven Principles (ETR:T3T1) Is Very Good At Capital Allocation

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at the ROCE trend of Seven Principles (ETR:T3T1) we really liked what we saw.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Seven Principles:

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

0.29 = €4.3m ÷ (€27m - €12m) (Based on the trailing twelve months to June 2022).

Therefore, Seven Principles has an ROCE of 29%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.

See our latest analysis for Seven Principles

Historical performance is a great place to start when researching a stock so above you can see the gauge for Seven Principles' ROCE against it's prior returns. If you'd like to look at how Seven Principles has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Seven Principles' ROCE Trending?

We're delighted to see that Seven Principles is reaping rewards from its investments and has now broken into profitability. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 29% on their capital employed. In regards to capital employed, Seven Principles is using 29% less capital than it was five years ago, which on the surface, can indicate that the business has become more efficient at generating these returns. Seven Principles could be selling under-performing assets since the ROCE is improving.

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 45% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

In Conclusion...

In a nutshell, we're pleased to see that Seven Principles has been able to generate higher returns from less capital. And since the stock has fallen 17% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

On a final note, we've found 3 warning signs for Seven Principles that we think you should be aware of.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.