INSPECS Group (LON:SPEC) Might Be Having Difficulty Using Its Capital Effectively

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after investigating INSPECS Group (LON:SPEC), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on INSPECS Group is:

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

0.049 = US$11m ÷ (US$302m - US$79m) (Based on the trailing twelve months to June 2022).

Thus, INSPECS Group has an ROCE of 4.9%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 9.9%.

Check out the opportunities and risks within the GB Medical Equipment industry.

In the above chart we have measured INSPECS Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering INSPECS Group here for free.

What Can We Tell From INSPECS Group's ROCE Trend?

In terms of INSPECS Group's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 15%, but since then they've fallen to 4.9%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, INSPECS Group has decreased its current liabilities to 26% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for INSPECS Group. Despite these promising trends, the stock has collapsed 88% over the last year, so there could be other factors hurting the company's prospects. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

If you'd like to know more about INSPECS Group, we've spotted 4 warning signs, and 3 of them make us uncomfortable.

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.