There Are Reasons To Feel Uneasy About Smart Metering Systems' (LON:SMS) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. 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. Analysts use this formula to calculate it for Smart Metering Systems:

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

0.05 = UK£34m ÷ (UK£765m - UK£85m) (Based on the trailing twelve months to June 2023).

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

See 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.

What Can We Tell From Smart Metering Systems' ROCE Trend?

In terms of Smart Metering Systems' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.0% from 6.4% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

What We Can Learn From Smart Metering Systems' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Smart Metering Systems is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 19% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

Smart Metering Systems does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...

While Smart Metering Systems isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.