Smith & Nephew (LON:SN.) Will Be Hoping To Turn Its Returns On Capital Around

When researching a stock for investment, what can tell us that the company is in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after glancing at the trends within Smith & Nephew (LON:SN.), we weren't too hopeful.

What Is 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. To calculate this metric for Smith & Nephew, this is the formula:

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

0.088 = US$682m ÷ (US$10.0b - US$2.3b) (Based on the trailing twelve months to December 2023).

So, Smith & Nephew has an ROCE of 8.8%. In absolute terms, that's a low return but it's around the Medical Equipment industry average of 7.9%.

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 to see what analysts are forecasting going forward, you should check out our free analyst report for Smith & Nephew .

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Smith & Nephew. To be more specific, the ROCE was 15% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Smith & Nephew becoming one if things continue as they have.

The Bottom Line

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. It should come as no surprise then that the stock has fallen 34% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Smith & Nephew (of which 1 shouldn't be ignored!) that you should know about.

While Smith & Nephew 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com