Returns On Capital Signal Tricky Times Ahead For Midwich Group (LON:MIDW)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Midwich Group (LON:MIDW) 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 Midwich Group:

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

0.049 = UK£7.6m ÷ (UK£306m - UK£150m) (Based on the trailing twelve months to December 2020).

Thus, Midwich Group has an ROCE of 4.9%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 11%.

Check out our latest analysis for Midwich Group

In the above chart we have measured Midwich Group'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 Midwich Group's ROCE Trending?

Unfortunately, the trend isn't great with ROCE falling from 56% five years ago, while capital employed has grown 589%. That being said, Midwich 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 Midwich Group might not have received a full period of earnings contribution from it.

On a side note, Midwich Group has done well to pay down its current liabilities to 49% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 49% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

To conclude, we've found that Midwich Group is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 186% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing to note, we've identified 1 warning sign with Midwich Group and understanding this should be part of your investment process.

While Midwich Group 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.
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