Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Speaking of which, we noticed some great changes in ShotSpotter's (NASDAQ:SSTI) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
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. To calculate this metric for ShotSpotter, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.073 = US$2.5m ÷ (US$64m - US$30m) (Based on the trailing twelve months to March 2021).
So, ShotSpotter has an ROCE of 7.3%. In absolute terms, that's a low return and it also under-performs the Software industry average of 11%.
In the above chart we have measured ShotSpotter's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for ShotSpotter.
How Are Returns Trending?
ShotSpotter has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 7.3% which is a sight for sore eyes. Not only that, but the company is utilizing 795% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 46%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.
To the delight of most shareholders, ShotSpotter has now broken into profitability. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 39% return over the last three years. Therefore, we think it would be worth your time to check if these trends are going to continue.
If you'd like to know about the risks facing ShotSpotter, we've discovered 5 warning signs that you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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