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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 Switch (NYSE:SWCH) 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. Analysts use this formula to calculate it for Switch:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = US$88m ÷ (US$2.1b - US$115m) (Based on the trailing twelve months to September 2020).
Therefore, Switch has an ROCE of 4.4%. Ultimately, that's a low return and it under-performs the IT industry average of 9.8%.
In the above chart we have measured Switch's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Switch's ROCE Trend?
In terms of Switch's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 8.0% over the last four 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. If these investments prove successful, this can bode very well for long term stock performance.
What We Can Learn From Switch's ROCE
While returns have fallen for Switch in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, total returns to shareholders over the last three years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Switch (of which 1 is potentially serious!) that you should know about.
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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