Returns On Capital Signal Tricky Times Ahead For SThree (LON:STEM)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So while SThree (LON:STEM) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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 SThree is:

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

0.37 = UK£67m ÷ (UK£401m - UK£218m) (Based on the trailing twelve months to November 2021).

Therefore, SThree has an ROCE of 37%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 13%.

View our latest analysis for SThree

In the above chart we have measured SThree's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for SThree.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at SThree doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 54%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, SThree has done well to pay down its current liabilities to 55% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

What We Can Learn From SThree's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that SThree is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 34% gain to shareholders who've held 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.

On a separate note, we've found 1 warning sign for SThree you'll probably want to know about.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.