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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. 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. Although, when we looked at Barrett Business Services (NASDAQ:BBSI), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for Barrett Business Services:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.084 = US$40m ÷ (US$823m - US$346m) (Based on the trailing twelve months to September 2020).
So, Barrett Business Services has an ROCE of 8.4%. In absolute terms, that's a low return but it's around the Professional Services industry average of 9.4%.
In the above chart we have measured Barrett Business Services' 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 Barrett Business Services.
What Does the ROCE Trend For Barrett Business Services Tell Us?
In terms of Barrett Business Services' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 8.4% from 16% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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.
On a related note, Barrett Business Services has decreased its current liabilities to 42% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 42% is still pretty high, so those risks are still somewhat prevalent.
What We Can Learn From Barrett Business Services' ROCE
Bringing it all together, while we're somewhat encouraged by Barrett Business Services' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 70% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Barrett Business Services does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is a bit concerning...
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.
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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