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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at J. Smart (Contractors) (LON:SMJ) so let's look a bit deeper.
Understanding 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 J. Smart (Contractors), this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.022 = UK£2.2m ÷ (UK£118m - UK£17m) (Based on the trailing twelve months to January 2020).
So, J. Smart (Contractors) has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Construction industry average of 18%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for J. Smart (Contractors)'s ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of J. Smart (Contractors), check out these free graphs here.
What Can We Tell From J. Smart (Contractors)'s ROCE Trend?
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 1652% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
Our Take On J. Smart (Contractors)'s ROCE
As discussed above, J. Smart (Contractors) appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Considering the stock has delivered 32% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
One more thing to note, we've identified 3 warning signs with J. Smart (Contractors) 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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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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