This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in Solution Dynamics Limited (NZSE:SDL).
Solution Dynamics stock represents an ownership share in the company. As a result, your investment is being put to work to fund operations and if you want to earn an attractive return on your investment, the business needs to be making an adequate amount of money from the funds you provide. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. To understand Solution Dynamics’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
Solution Dynamics’s Return On Capital Employed
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. Accordingly, before you invest you need to assess the capital returns that the company has produced with reference to a certain benchmark to ensure that you are confident in the business’ ability to grow your capital at a level that grants an investment over other companies. We’ll look at Solution Dynamics’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. I have calculated Solution Dynamics’s ROCE for you below:
ROCE Calculation for SDL
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = NZ$2.1m ÷ (NZ$8.0m – NZ$4.0m) = 51%
As you can see, SDL earned NZ$51.1 from every NZ$100 you invested over the previous twelve months. Comparing this to a healthy 15% benchmark shows Solution Dynamics is currently able to return a fantastic amount to owners for the use of their capital, which is a good sign for those who believe this will continue and the company’s management will find good uses for the earnings they create.
Before moving forward
Solution Dynamics’s relatively strong ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Solution Dynamics is in a favourable position, but this can change if these factors underperform. Because of this, it is important to look beyond the final value of SDL’s ROCE and understand what is happening to the individual components. Three years ago, SDL’s ROCE was 32%, which means the company’s capital returns have improved. We can see that earnings have increased from NZ$831k to NZ$2.1m whilst capital employed also increased but to a smaller extent, which means the company has been able to improve ROCE by driving up earnings relative to the capital invested in the business.
Solution Dynamics’s ROCE has increased in the recent past and is above a benchmark that makes the company a potentially attractive stock that can achieve a solid return on investment. This is an ideal situation to be in, but return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. Without considering these fundamentals, you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. Solution Dynamics’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Future Outlook: What are well-informed industry analysts predicting for SDL’s future growth? Take a look at our free research report of analyst consensus for SDL’s outlook.
- Valuation: What is SDL worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether SDL is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.