There Are Reasons To Feel Uneasy About Össur hf's (CPH:OSSR) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Össur hf (CPH:OSSR), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Össur hf:

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

0.077 = US$72m ÷ (US$1.3b - US$344m) (Based on the trailing twelve months to September 2022).

So, Össur hf has an ROCE of 7.7%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.7%.

Our analysis indicates that OSSR is potentially undervalued!

In the above chart we have measured Össur hf'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.

How Are Returns Trending?

When we looked at the ROCE trend at Össur hf, we didn't gain much confidence. To be more specific, ROCE has fallen from 11% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Össur hf's current liabilities have increased over the last five years to 27% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 7.7%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From Össur hf's ROCE

Bringing it all together, while we're somewhat encouraged by Össur hf's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 19% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

One more thing to note, we've identified 1 warning sign with Össur hf and understanding it should be part of your investment process.

While Össur hf 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.