Severfield (LON:SFR) Shareholders Will Want The ROCE Trajectory To Continue

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. So on that note, Severfield (LON:SFR) looks quite promising in regards to its trends of return on capital.

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Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Severfield is:

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

0.12 = UK£32m ÷ (UK£388m - UK£133m) (Based on the trailing twelve months to September 2024).

Thus, Severfield has an ROCE of 12%. In isolation, that's a pretty standard return but against the Construction industry average of 18%, it's not as good.

See our latest analysis for Severfield

In the above chart we have measured Severfield's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Severfield .

So How Is Severfield's ROCE Trending?

Severfield is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 12%. The amount of capital employed has increased too, by 25%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 34% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line

In summary, it's great to see that Severfield can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Astute investors may have an opportunity here because the stock has declined 24% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.

On a final note, we found 4 warning signs for Severfield (1 doesn't sit too well with us) you should be aware of.

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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.