Samuel Heath & Sons (LON:HSM) Is Reinvesting At Lower Rates Of Return

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Although, when we looked at Samuel Heath & Sons (LON:HSM), 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. Analysts use this formula to calculate it for Samuel Heath & Sons:

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

0.031 = UK£368k ÷ (UK£14m - UK£1.9m) (Based on the trailing twelve months to September 2020).

Therefore, Samuel Heath & Sons has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Building industry average of 5.9%.

See our latest analysis for Samuel Heath & Sons

Historical performance is a great place to start when researching a stock so above you can see the gauge for Samuel Heath & Sons' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Samuel Heath & Sons, check out these free graphs here.

What Does the ROCE Trend For Samuel Heath & Sons Tell Us?

In terms of Samuel Heath & Sons' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 11% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

The Bottom Line On Samuel Heath & Sons' ROCE

We're a bit apprehensive about Samuel Heath & Sons because despite more capital being deployed in the business, returns on that capital and sales have both fallen. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 48% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Samuel Heath & Sons (of which 1 doesn't sit too well with us!) that you should know about.

While Samuel Heath & Sons isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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.
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