Returns On Capital At Snam (BIT:SRG) Have Hit The Brakes

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Snam (BIT:SRG), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Snam:

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

0.067 = €1.4b ÷ (€32b - €12b) (Based on the trailing twelve months to December 2022).

Thus, Snam has an ROCE of 6.7%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.9%.

See our latest analysis for Snam

In the above chart we have measured Snam's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Snam here for free.

What Can We Tell From Snam's ROCE Trend?

There hasn't been much to report for Snam's returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at Snam in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. That being the case, it makes sense that Snam has been paying out 80% of its earnings to its shareholders. Most shareholders probably know this and own the stock for its dividend.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 36% of total assets, this reported ROCE would probably be less than6.7% because total capital employed would be higher.The 6.7% ROCE could be even lower if current liabilities weren't 36% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

The Bottom Line On Snam's ROCE

In summary, Snam isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Although the market must be expecting these trends to improve because the stock has gained 71% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a final note, we've found 4 warning signs for Snam that we think you should be aware of.

While Snam may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.