If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. So when we looked at STV Group (LON:STVG), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on STV Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = UK£17m ÷ (UK£96m - UK£24m) (Based on the trailing twelve months to December 2020).
Therefore, STV Group has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Media industry average of 8.9%.
In the above chart we have measured STV Group'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 report for STV Group.
What Can We Tell From STV Group's ROCE Trend?
We weren't thrilled with the trend because STV Group's ROCE has reduced by 30% over the last five years, while the business employed 23% more capital. That being said, STV Group raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence STV Group might not have received a full period of earnings contribution from it.
What We Can Learn From STV Group's ROCE
In summary, we're somewhat concerned by STV Group's diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 14% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
If you'd like to know more about STV Group, we've spotted 6 warning signs, and 1 of them is potentially serious.
STV Group is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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