Capital Allocation Trends At Scotts Miracle-Gro (NYSE:SMG) Aren't Ideal
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Scotts Miracle-Gro (NYSE:SMG), it didn't seem to tick all of these boxes.
What Is Return On Capital Employed (ROCE)?
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 Scotts Miracle-Gro is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$406m ÷ (US$5.0b - US$1.4b) (Based on the trailing twelve months to April 2023).
Therefore, Scotts Miracle-Gro has an ROCE of 11%. By itself that's a normal return on capital and it's in line with the industry's average returns of 11%.
See our latest analysis for Scotts Miracle-Gro
Above you can see how the current ROCE for Scotts Miracle-Gro compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
On the surface, the trend of ROCE at Scotts Miracle-Gro doesn't inspire confidence. Over the last five years, returns on capital have decreased to 11% from 15% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
In Conclusion...
We're a bit apprehensive about Scotts Miracle-Gro because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 12% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
On a final note, we found 3 warning signs for Scotts Miracle-Gro (1 is potentially serious) 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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