This article is intended for those of you who are at the beginning of your investing journey and want a simplistic look at the return on The LS Starrett Company (NYSE:SCX) stock.
If you purchase a SCX share you are effectively becoming a partner with many other shareholders. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. 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 L.S. Starrett’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.
See our latest analysis for L.S. Starrett
What is Return on Capital Employed (ROCE)?
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. 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. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if L.S. Starrett is good at growing investor capital. I have calculated L.S. Starrett’s ROCE for you below:
ROCE Calculation for SCX
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$3.15m ÷ (US$191.67m – US$26.07m) = 1.90%
The calculation above shows that SCX’s earnings were 1.90% of capital employed. This shows L.S. Starrett provides an unsatisfying capital return that is well below the 15% ROCE that is typically considered to be a strong benchmark. Nevertheless, if SCX is clever with their reinvestments or dividend payments, investors can still grow their capital although to a poor extent.
A deeper look
SCX doesn’t return an attractive amount on capital, but this will only continue if the company is unable to increase earnings or decrease current capital requirements. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Three years ago, SCX’s ROCE was 8.15%, which means the company’s capital returns have worsened. With this, the current earnings of US$3.15m actually declined from US$15.09m whilst the amount of capital employed also fell but by a proportionally lesser volume, which suggests the smaller ROCE is due to a decline in earnings relative to capital requirements.
Next Steps
ROCE for SCX investors has fallen in the last few years and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. However, it is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as the management team. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate SCX or move on to other alternatives.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for L.S. Starrett’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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 editorial-team@simplywallst.com.