Is There More Growth In Store For Spectra Systems' (LON:SPSC) Returns On Capital?

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Spectra Systems (LON:SPSC) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Spectra Systems, this is the formula:

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

0.17 = US$4.3m ÷ (US$28m - US$2.2m) (Based on the trailing twelve months to June 2020).

Thus, Spectra Systems has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 8.2% it's much better.

View our latest analysis for Spectra Systems

In the above chart we have measured Spectra Systems' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Spectra Systems here for free.

What Does the ROCE Trend For Spectra Systems Tell Us?

We're delighted to see that Spectra Systems is reaping rewards from its investments and has now broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 17%, which is always encouraging. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.

The Key Takeaway

In summary, we're delighted to see that Spectra Systems has been able to increase efficiencies and earn higher rates of return on the same amount of capital. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.

Like most companies, Spectra Systems does come with some risks, and we've found 1 warning sign that you should be aware of.

While Spectra Systems 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. 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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