Here's What's Concerning About ScS Group's (LON:SCS) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think ScS Group (LON:SCS) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on ScS Group is:

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

0.054 = UK£7.7m ÷ (UK£242m - UK£98m) (Based on the trailing twelve months to January 2021).

Thus, ScS Group has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 12%.

Check out our latest analysis for ScS Group

Above you can see how the current ROCE for ScS Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering ScS Group here for free.

What The Trend Of ROCE Can Tell Us

Unfortunately, the trend isn't great with ROCE falling from 32% five years ago, while capital employed has grown 454%. Usually this isn't ideal, but given ScS Group conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. ScS Group 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, ScS Group has done well to pay down its current liabilities to 40% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for ScS Group have fallen, meanwhile the business is employing more capital than it was five years ago. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 147%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing: We've identified 3 warning signs with ScS Group (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

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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