Capital Allocation Trends At Savencia (EPA:SAVE) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Savencia (EPA:SAVE) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Savencia:

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

0.069 = €163m ÷ (€4.6b - €2.2b) (Based on the trailing twelve months to December 2022).

Therefore, Savencia has an ROCE of 6.9%. In absolute terms, that's a low return but it's around the Food industry average of 5.8%.

Check out our latest analysis for Savencia

In the above chart we have measured Savencia'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.

SWOT Analysis for Savencia

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Savencia, we didn't gain much confidence. To be more specific, ROCE has fallen from 9.4% over the last five years. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Another thing to note, Savencia has a high ratio of current liabilities to total assets of 49%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Savencia's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Savencia. And there could be an opportunity here if other metrics look good too, because the stock has declined 18% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a separate note, we've found 1 warning sign for Savencia you'll probably want to know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.