Investors Met With Slowing Returns on Capital At Electrocomponents (LON:ECM)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, the ROCE of Electrocomponents (LON:ECM) looks decent, right now, so lets see what the trend of returns can tell us.

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 Electrocomponents, this is the formula:

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

0.14 = UK£170m ÷ (UK£1.8b - UK£631m) (Based on the trailing twelve months to March 2021).

So, Electrocomponents has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 13% generated by the Trade Distributors industry.

View our latest analysis for Electrocomponents

In the above chart we have measured Electrocomponents' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Electrocomponents here for free.

So How Is Electrocomponents' ROCE Trending?

The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has consistently earned 14% for the last five years, and the capital employed within the business has risen 84% in that time. Since 14% 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.

On a side note, Electrocomponents has done well to reduce current liabilities to 34% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

The Key Takeaway

The main thing to remember is that Electrocomponents has proven its ability to continually reinvest at respectable rates of return. And the stock has done incredibly well with a 258% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

One more thing, we've spotted 1 warning sign facing Electrocomponents that you might find interesting.

While Electrocomponents 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. 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.
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