What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Santova (JSE:SNV) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Santova is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = R108m ÷ (R1.2b - R538m) (Based on the trailing twelve months to February 2020).
Thus, Santova has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 6.7% generated by the Logistics industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Santova's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Santova, check out these free graphs here.
What Can We Tell From Santova's ROCE Trend?
When we looked at the ROCE trend at Santova, we didn't gain much confidence. Around five years ago the returns on capital were 22%, but since then they've fallen to 17%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.On a side note, Santova has done well to pay down its current liabilities to 46% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 46% is still pretty high, so those risks are still somewhat prevalent.
The Key Takeaway
In summary, despite lower returns in the short term, we're encouraged to see that Santova is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 42% in the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
On a final note, we've found 2 warning signs for Santova that we think you should be aware of.
While Santova 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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