Returns At Scandinavian Tobacco Group (CPH:STG) Are On The Way Up

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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Scandinavian Tobacco Group's (CPH:STG) returns on capital, so let's have a look.

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. To calculate this metric for Scandinavian Tobacco Group, this is the formula:

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

0.13 = kr.1.8b ÷ (kr.16b - kr.1.5b) (Based on the trailing twelve months to June 2022).

Therefore, Scandinavian Tobacco Group has an ROCE of 13%. That's a relatively normal return on capital, and it's around the 15% generated by the Tobacco industry.

Our analysis indicates that STG is potentially undervalued!

In the above chart we have measured Scandinavian Tobacco Group'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 The Trend Of ROCE Can Tell Us

Scandinavian Tobacco Group's ROCE growth is quite impressive. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 63% in that same time. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

In Conclusion...

In summary, we're delighted to see that Scandinavian Tobacco Group has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Since the stock has returned a solid 50% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

One more thing: We've identified 2 warning signs with Scandinavian Tobacco Group (at least 1 which doesn't sit too well with us) , and understanding these would certainly be useful.

While Scandinavian Tobacco Group 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.