Here's What's Concerning About Profithol's (BME:SPH) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Looking at Profithol (BME:SPH), it does have a high ROCE right now, but lets see how returns are trending.

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. To calculate this metric for Profithol, this is the formula:

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

0.30 = €7.6m ÷ (€41m - €16m) (Based on the trailing twelve months to December 2021).

Thus, Profithol has an ROCE of 30%. In absolute terms that's a great return and it's even better than the Electrical industry average of 6.9%.

See our latest analysis for Profithol

In the above chart we have measured Profithol's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Profithol.

What Does the ROCE Trend For Profithol Tell Us?

On the surface, the trend of ROCE at Profithol doesn't inspire confidence. While it's comforting that the ROCE is high, two years ago it was 57%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Profithol has done well to pay down its current liabilities to 40% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Profithol's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Profithol is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 62% over the last year, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Profithol (of which 3 are concerning!) that you should know about.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.