Stock Analysis

There Are Reasons To Feel Uneasy About SSE's (LON:SSE) Returns On Capital

LSE:SSE
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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at SSE (LON:SSE) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper 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. To calculate this metric for SSE, this is the formula:

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

0.019 = UK£406m ÷ (UK£29b - UK£6.6b) (Based on the trailing twelve months to September 2022).

Thus, SSE has an ROCE of 1.9%. Ultimately, that's a low return and it under-performs the Electric Utilities industry average of 8.4%.

See our latest analysis for SSE

roce
LSE:SSE Return on Capital Employed March 16th 2023

In the above chart we have measured SSE's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for SSE.

What Does the ROCE Trend For SSE Tell Us?

When we looked at the ROCE trend at SSE, we didn't gain much confidence. Around five years ago the returns on capital were 9.2%, but since then they've fallen to 1.9%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for SSE. And the stock has followed suit returning a meaningful 92% to shareholders over the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you want to know some of the risks facing SSE we've found 4 warning signs (2 are a bit concerning!) that you should be aware of before investing here.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Valuation is complex, but we're helping make it simple.

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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.