Capital Allocation Trends At Sidetrade (EPA:ALBFR) Aren't Ideal

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Sidetrade (EPA:ALBFR), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on Sidetrade is:

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

0.10 = €2.9m ÷ (€36m - €7.5m) (Based on the trailing twelve months to June 2020).

Thus, Sidetrade has an ROCE of 10%. By itself that's a normal return on capital and it's in line with the industry's average returns of 10%.

Check out our latest analysis for Sidetrade

In the above chart we have measured Sidetrade'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?

We weren't thrilled with the trend because Sidetrade's ROCE has reduced by 33% over the last five years, while the business employed 201% more capital. That being said, Sidetrade raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Sidetrade might not have received a full period of earnings contribution from it.

On a related note, Sidetrade has decreased its current liabilities to 21% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Sidetrade's ROCE

While returns have fallen for Sidetrade in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 410% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing to note, we've identified 2 warning signs with Sidetrade and understanding these should be part of your investment process.

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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