Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at Stalprofil (WSE:STF) so let's look a bit deeper.
Understanding Return On Capital Employed (ROCE)
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. Analysts use this formula to calculate it for Stalprofil:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = zł33m ÷ (zł984m - zł518m) (Based on the trailing twelve months to September 2020).
So, Stalprofil has an ROCE of 7.0%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 13%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Stalprofil's ROCE against it's prior returns. If you'd like to look at how Stalprofil has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
Shareholders will be relieved that Stalprofil has broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 7.0%, which is always encouraging. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 53% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
What We Can Learn From Stalprofil's ROCE
As discussed above, Stalprofil appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 15% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
Like most companies, Stalprofil does come with some risks, and we've found 3 warning signs that you should be aware of.
While Stalprofil 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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