Investors Could Be Concerned With M&C Saatchi's (LON:SAA) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. 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 M&C Saatchi (LON:SAA) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for M&C Saatchi:

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

0.17 = UK£18m ÷ (UK£312m - UK£205m) (Based on the trailing twelve months to December 2020).

So, M&C Saatchi has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 9.9% generated by the Media industry.

View our latest analysis for M&C Saatchi

Above you can see how the current ROCE for M&C Saatchi compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

The trend of ROCE doesn't look fantastic because it's fallen from 22% five years ago, while the business's capital employed increased by 39%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. M&C Saatchi probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a side note, M&C Saatchi's current liabilities have increased over the last five years to 66% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 17%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Key Takeaway

In summary, we're somewhat concerned by M&C Saatchi's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 53% 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.

If you'd like to know about the risks facing M&C Saatchi, we've discovered 4 warning signs that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. 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.
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