Here's What's Concerning About Standard Motor Products' (NYSE:SMP) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Standard Motor Products (NYSE:SMP) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

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. The formula for this calculation on Standard Motor Products is:

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

0.15 = US$138m ÷ (US$1.3b - US$374m) (Based on the trailing twelve months to September 2022).

Thus, Standard Motor Products has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Auto Components industry average of 13%.

Our analysis indicates that SMP is potentially undervalued!

In the above chart we have measured Standard Motor Products' 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 Standard Motor Products here for free.

How Are Returns Trending?

In terms of Standard Motor Products' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 23% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

What We Can Learn From Standard Motor Products' ROCE

In summary, Standard Motor Products is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Additionally, the stock's total return to shareholders over the last five years has been flat, which isn't too surprising. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Standard Motor Products (of which 2 are significant!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.