Mercury Systems (NASDAQ:MRCY) Could Be Struggling To Allocate Capital

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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Mercury Systems (NASDAQ:MRCY) 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 Mercury Systems is:

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

0.027 = US$58m ÷ (US$2.3b - US$182m) (Based on the trailing twelve months to September 2022).

Thus, Mercury Systems has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Aerospace & Defense industry average of 9.3%.

See our latest analysis for Mercury Systems

Above you can see how the current ROCE for Mercury Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Mercury Systems here for free.

How Are Returns Trending?

When we looked at the ROCE trend at Mercury Systems, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.7% from 6.6% five years ago. However it looks like Mercury Systems might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line On Mercury Systems' ROCE

To conclude, we've found that Mercury Systems is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 1.7% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

If you want to continue researching Mercury Systems, you might be interested to know about the 3 warning signs that our analysis has discovered.

While Mercury Systems 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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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.