Capital Allocation Trends At VSE (NASDAQ:VSEC) Aren't Ideal
What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think VSE (NASDAQ:VSEC) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on VSE is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = US$54m ÷ (US$958m - US$180m) (Based on the trailing twelve months to September 2022).
Thus, VSE has an ROCE of 7.0%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 9.9%.
Check out our latest analysis for VSE
In the above chart we have measured VSE's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering VSE here for free.
What Can We Tell From VSE's ROCE Trend?
When we looked at the ROCE trend at VSE, we didn't gain much confidence. To be more specific, ROCE has fallen from 11% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
Our Take On VSE's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for VSE. In light of this, the stock has only gained 20% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.
One more thing: We've identified 2 warning signs with VSE (at least 1 which is concerning) , and understanding them would certainly be useful.
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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