Stock Analysis

Returns Are Gaining Momentum At SSE (LON:SSE)

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LSE:SSE
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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. With that in mind, we've noticed some promising trends at SSE (LON:SSE) so let's look a bit deeper.

Understanding 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. To calculate this metric for SSE, this is the formula:

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

0.16 = UK£2.9b ÷ (UK£23b - UK£5.6b) (Based on the trailing twelve months to September 2021).

So, SSE has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 7.2% generated by the Electric Utilities industry.

See our latest analysis for SSE

roce
LSE:SSE Return on Capital Employed January 22nd 2022

Above you can see how the current ROCE for SSE compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From SSE's ROCE Trend?

SSE is showing promise given that its ROCE is trending up and to the right. The figures show that over the last five years, ROCE has grown 40% whilst employing roughly the same amount of capital. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

In Conclusion...

As discussed above, SSE appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 45% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for SSE (of which 1 shouldn't be ignored!) that you should know about.

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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