What Do The Returns On Capital At Spirax-Sarco Engineering (LON:SPX) Tell Us?

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. However, after investigating Spirax-Sarco Engineering (LON:SPX), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for Spirax-Sarco Engineering:

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

0.16 = UK£254m ÷ (UK£1.9b - UK£352m) (Based on the trailing twelve months to June 2020).

Thus, Spirax-Sarco Engineering has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 8.9% generated by the Machinery industry.

Check out our latest analysis for Spirax-Sarco Engineering

Above you can see how the current ROCE for Spirax-Sarco Engineering compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Spirax-Sarco Engineering here for free.

What Can We Tell From Spirax-Sarco Engineering's ROCE Trend?

On the surface, the trend of ROCE at Spirax-Sarco Engineering doesn't inspire confidence. Over the last five years, returns on capital have decreased to 16% from 31% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Spirax-Sarco Engineering has decreased its current liabilities to 19% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

In summary, Spirax-Sarco Engineering is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 245% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you want to continue researching Spirax-Sarco Engineering, you might be interested to know about the 1 warning sign that our analysis has discovered.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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