Be Wary Of Somec (BIT:SOM) And Its Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Somec (BIT:SOM), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on Somec is:

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

0.016 = €2.0m ÷ (€246m - €118m) (Based on the trailing twelve months to December 2020).

Thus, Somec has an ROCE of 1.6%. In absolute terms, that's a low return and it also under-performs the Building industry average of 12%.

View our latest analysis for Somec

In the above chart we have measured Somec's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

In terms of Somec's historical ROCE movements, the trend isn't fantastic. Around three years ago the returns on capital were 13%, but since then they've fallen to 1.6%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Somec has done well to pay down its current liabilities to 48% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 48% is still pretty high, so those risks are still somewhat prevalent.

Our Take On Somec's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Somec have fallen, meanwhile the business is employing more capital than it was three years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 39% return over the last three years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing: We've identified 4 warning signs with Somec (at least 1 which shouldn't be ignored) , and understanding these would certainly be useful.

While Somec 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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This article by Simply Wall St is general in nature. 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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