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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at Standard Motor Products' (NYSE:SMP) ROCE trend, we were pretty happy with what we saw.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Standard Motor Products:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$112m ÷ (US$957m - US$303m) (Based on the trailing twelve months to December 2020).
Therefore, Standard Motor Products has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Auto Components industry average of 9.3% it's much better.
Above you can see how the current ROCE for Standard Motor Products 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.
So How Is Standard Motor Products' ROCE Trending?
While the current returns on capital are decent, they haven't changed much. The company has consistently earned 17% for the last five years, and the capital employed within the business has risen 49% in that time. 17% is a pretty standard return, and it provides some comfort knowing that Standard Motor Products has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
The Key Takeaway
The main thing to remember is that Standard Motor Products has proven its ability to continually reinvest at respectable rates of return. And the stock has followed suit returning a meaningful 47% to shareholders over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
If you want to know some of the risks facing Standard Motor Products we've found 2 warning signs (1 can't be ignored!) that you should be aware of before investing here.
While Standard Motor Products isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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