What Can The Trends At Spectra Systems (LON:SPSC) Tell Us About Their Returns?

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Spectra Systems' (LON:SPSC) returns on capital, so let's have a look.

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 Spectra Systems is:

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%. On its own, that's a standard return, however it's much better than the 8.4% generated by the Electronic industry.

Check out 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.

The Trend Of ROCE

We're delighted to see that Spectra Systems is reaping rewards from its investments and has now broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 17% on its capital. 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. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.

The Bottom Line

As discussed above, Spectra Systems appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a staggering 942% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Spectra Systems can keep these trends up, it could have a bright future ahead.

If you want to continue researching Spectra Systems, you might be interested to know about the 2 warning signs that our analysis has discovered.

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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