Returns On Capital Signal Tricky Times Ahead For Snam (BIT:SRG)

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Having said that, from a first glance at Snam (BIT:SRG) 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. Analysts use this formula to calculate it for Snam:

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

0.064 = €1.5b ÷ (€24b - €957m) (Based on the trailing twelve months to December 2023).

Thus, Snam has an ROCE of 6.4%. On its own that's a low return, but compared to the average of 5.3% generated by the Gas Utilities industry, it's much better.

Check out 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 for free.

What Can We Tell From Snam's ROCE Trend?

When we looked at the ROCE trend at Snam, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.4% from 8.2% 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. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Snam has done well to pay down its current liabilities to 4.0% 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.

What We Can Learn From Snam's ROCE

While returns have fallen for Snam in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. In light of this, the stock has only gained 25% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

Snam does have some risks though, and we've spotted 2 warning signs for Snam that you might be interested in.

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.