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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Signet Industries (NSE:SIGIND), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Signet Industries:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = ₹533m ÷ (₹7.4b - ₹4.7b) (Based on the trailing twelve months to December 2021).
Thus, Signet Industries has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 7.5% earned by companies in a similar industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Signet Industries has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
In terms of Signet Industries' historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 29% where it was five years ago. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
Another thing to note, Signet Industries has a high ratio of current liabilities to total assets of 63%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Signet Industries is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 63% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
One more thing: We've identified 5 warning signs with Signet Industries (at least 2 which don't sit too well with us) , and understanding them would certainly be useful.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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.