If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. 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 STG International (TLV:STG) 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 STG International, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.046 = ₪3.8m ÷ (₪112m - ₪30m) (Based on the trailing twelve months to June 2021).
Therefore, STG International has an ROCE of 4.6%. Ultimately, that's a low return and it under-performs the Electronic industry average of 7.5%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for STG International's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of STG International, check out these free graphs here.
The Trend Of ROCE
STG International has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 4.6% which is a sight for sore eyes. In addition to that, STG International is employing 25% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 27% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
Our Take On STG International's ROCE
To the delight of most shareholders, STG International has now broken into profitability. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 91% return over the last five years. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
One more thing, we've spotted 3 warning signs facing STG International that you might find interesting.
While STG International isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.
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