This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on Sensient Technologies Corporation (NYSE:SXT) stock.
Buying Sensient Technologies makes you a partial owner of the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. To understand Sensient Technologies’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.
Calculating Return On Capital Employed for SXT
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. To determine Sensient Technologies’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). Take a look at the formula box beneath:
ROCE Calculation for SXT
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$187m ÷ (US$1.8b – US$194m) = 13%
As you can see, SXT earned $12.7 from every $100 you invested over the previous twelve months. Comparing this to a healthy 15% benchmark shows Sensient Technologies is currently unable to return a desired amount to owners for the use of their capital, which isn’t favourable for investors who have forgone other potentially solid companies.
Then why have investors invested?
The underperforming ROCE is not ideal for Sensient Technologies investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, SXT’s ROCE may increase, in which case your portfolio could benefit from holding the company. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Looking at the past 3 year period shows us that SXT weakened investor return on capital employed from 14%. The movement in the earnings variable over this time shows a fall from US$202m to US$187m whilst capital employed has increased due to a hike in the level of total assets and a smaller reliance on current liabilities (less borrowing to fund operations) , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.
ROCE for SXT 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. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. Sensient Technologies’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Future Outlook: What are well-informed industry analysts predicting for SXT’s future growth? Take a look at our free research report of analyst consensus for SXT’s outlook.
- Valuation: What is SXT worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether SXT is currently undervalued by the market.
- 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 email@example.com.