Some Investors May Be Worried About Smith & Nephew's (LON:SN.) 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? 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. 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.

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. Analysts use this formula to calculate it for Smith & Nephew:

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

0.081 = US$712m ÷ (US$11b - US$2.1b) (Based on the trailing twelve months to December 2021).

Thus, Smith & Nephew has an ROCE of 8.1%. On its own, that's a low figure but it's around the 10% average generated by the Medical Equipment industry.

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Smith & Nephew's ROCE Trending?

On the surface, the trend of ROCE at Smith & Nephew doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 8.1%. 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.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Smith & Nephew. In light of this, the stock has only gained 14% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

While Smith & Nephew doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

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.