If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after briefly looking over the numbers, we don't think Summit Materials (NYSE:SUM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What is 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 Summit Materials:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = US$234m ÷ (US$4.4b - US$322m) (Based on the trailing twelve months to April 2021).
Therefore, Summit Materials has an ROCE of 5.8%. Ultimately, that's a low return and it under-performs the Basic Materials industry average of 13%.
Above you can see how the current ROCE for Summit Materials compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Summit Materials.
How Are Returns Trending?
In terms of Summit Materials' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.8% from 7.3% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by Summit Materials' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 45% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 5 warning signs for Summit Materials (of which 1 makes us a bit uncomfortable!) that you should know about.
While Summit Materials may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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This article by Simply Wall St is general in nature. 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.
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