Here's What's Concerning About Smart Metering Systems' (LON:SMS) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Smart Metering Systems (LON:SMS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for Smart Metering Systems, this is the formula:

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

0.05 = UK£22m ÷ (UK£495m - UK£60m) (Based on the trailing twelve months to June 2021).

Thus, Smart Metering Systems has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 11%.

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Smart Metering Systems' ROCE Trending?

On the surface, the trend of ROCE at Smart Metering Systems doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 5.0%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

The Bottom Line

In summary, we're somewhat concerned by Smart Metering Systems' diminishing returns on increasing amounts of capital. However the stock has delivered a 76% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with Smart Metering Systems (including 1 which is a bit concerning) .

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. 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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