I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Solid State plc (LON:SOLI).
Buying Solid State makes you a partial owner of the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Therefore, looking at how efficiently Solid State is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
ROCE: Explanation and Calculation
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. Accordingly, before you invest you need to assess the capital returns that the company has produced with reference to a certain benchmark to ensure that you are confident in the business’ ability to grow your capital at a level that grants an investment over other companies. To determine Solid State’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). Take a look at the formula box beneath:
ROCE Calculation for SOLI
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = UK£3m ÷ (UK£26m – UK£7m) = 14%
SOLI’s 14% ROCE means that for every £100 you invest, the company creates £14.3. This makes Solid State slightly mediocre when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future, investor capital will be able to compound over time, but still may be missing out on some potential growth elsewhere.
Why is this the case?
The underperforming ROCE is not ideal for Solid State investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, SOLI’s ROCE may increase, in which case your portfolio could benefit from holding the company. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Looking at the past 3 year period shows us that SOLI weakened investor return on capital employed from 24%. In this time, earnings have fallen from UK£3m to UK£3m and capital employed has increased due to an increase in total assets and a smaller reliance on current liabilities (less borrowing to fund operations) , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.
Solid State’s ROCE has decreased in the recent past and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for SOLI’s future growth? Take a look at our free research report of analyst consensus for SOLI’s outlook.
- Valuation: What is SOLI worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether SOLI is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.