What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So on that note, Smith-Midland (NASDAQ:SMID) looks quite promising in regards to its trends of return on capital.
What is Return On Capital Employed (ROCE)?
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 Smith-Midland is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$7.6m ÷ (US$51m - US$12m) (Based on the trailing twelve months to March 2021).
Thus, Smith-Midland has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 14% generated by the Basic Materials industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Smith-Midland's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Smith-Midland, check out these free graphs here.
What Does the ROCE Trend For Smith-Midland Tell Us?
Investors would be pleased with what's happening at Smith-Midland. Over the last five years, returns on capital employed have risen substantially to 19%. The amount of capital employed has increased too, by 170%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
The Bottom Line
In summary, it's great to see that Smith-Midland can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Smith-Midland can keep these trends up, it could have a bright future ahead.
If you'd like to know about the risks facing Smith-Midland, we've discovered 2 warning signs that you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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