Investors Could Be Concerned With Smith & Nephew's (LON:SN.) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Smith & Nephew (LON:SN.) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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 Smith & Nephew is:

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

0.081 = US$665m ÷ (US$10.0b - US$1.7b) (Based on the trailing twelve months to December 2022).

Therefore, Smith & Nephew has an ROCE of 8.1%. Even though it's in line with the industry average of 8.4%, it's still a low return by itself.

View our latest analysis for Smith & Nephew

In the above chart we have measured Smith & Nephew'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 Smith & Nephew here for free.

The Trend Of ROCE

In terms of Smith & Nephew's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 13% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

The Key Takeaway

In summary, Smith & Nephew is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly then, the total return to shareholders over the last five years has been flat. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One more thing: We've identified 4 warning signs with Smith & Nephew (at least 2 which make us uncomfortable) , and understanding them would certainly be useful.

While Smith & Nephew may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.