The Returns On Capital At Smart Metering Systems (LON:SMS) Don't Inspire Confidence

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Smart Metering Systems (LON:SMS), it didn't seem to tick all of these boxes.

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

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

0.039 = UK£17m ÷ (UK£495m - UK£60m) (Based on the trailing twelve months to June 2021).

Therefore, Smart Metering Systems has an ROCE of 3.9%. 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

In the above chart we have measured Smart Metering Systems' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

On the surface, the trend of ROCE at Smart Metering Systems doesn't inspire confidence. Over the last five years, returns on capital have decreased to 3.9% from 15% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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

From the above analysis, we find it rather worrisome that returns on capital and sales for Smart Metering Systems have fallen, meanwhile the business is employing more capital than it was five years ago. In spite of that, the stock has delivered a 32% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a final note, we found 4 warning signs for Smart Metering Systems (1 can't be ignored) you should be aware of.

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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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.