Here's What To Make Of Smart Metering Systems' (LON:SMS) Decelerating Rates Of Return

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'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at Smart Metering Systems (LON:SMS), it didn't seem to tick all of these boxes.

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

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. The formula for this calculation on Smart Metering Systems is:

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

0.047 = UK£30m ÷ (UK£697m - UK£72m) (Based on the trailing twelve months to December 2022).

Therefore, Smart Metering Systems has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 9.1%.

View our latest analysis for Smart Metering Systems

Above you can see how the current ROCE for Smart Metering Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Smart Metering Systems.

So How Is Smart Metering Systems' ROCE Trending?

The returns on capital haven't changed much for Smart Metering Systems in recent years. The company has employed 56% more capital in the last five years, and the returns on that capital have remained stable at 4.7%. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

The Key Takeaway

In conclusion, Smart Metering Systems has been investing more capital into the business, but returns on that capital haven't increased. Unsurprisingly, the stock has only gained 27% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing to note, we've identified 2 warning signs with Smart Metering Systems 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.