What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. That's why when we briefly looked at London Security's (LON:LSC) ROCE trend, we were pretty happy with what we saw.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for London Security, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = UK£21m ÷ (UK£171m - UK£35m) (Based on the trailing twelve months to June 2020).
Therefore, London Security has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 12% generated by the Machinery industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of London Security, check out these free graphs here.
The Trend Of ROCE
The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has consistently earned 16% for the last five years, and the capital employed within the business has risen 30% in that time. Since 16% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
The Key Takeaway
To sum it up, London Security has simply been reinvesting capital steadily, at those decent rates of return. However, over the last five years, the stock has only delivered a 31% return to shareholders who held over that period. So to determine if London Security is a multi-bagger going forward, we'd suggest digging deeper into the company's other fundamentals.
One more thing, we've spotted 1 warning sign facing London Security that you might find interesting.
While London Security 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.
When trading London Security or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.