Here's What's Concerning About Smith-Midland's (NASDAQ:SMID) Returns On Capital
If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Smith-Midland (NASDAQ:SMID) and its ROCE trend, we weren't exactly thrilled.
What Is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Smith-Midland, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.017 = US$749k ÷ (US$54m - US$11m) (Based on the trailing twelve months to September 2022).
Thus, Smith-Midland has an ROCE of 1.7%. In absolute terms, that's a low return and it also under-performs the Basic Materials industry average of 9.1%.
See our latest analysis for Smith-Midland
Historical performance is a great place to start when researching a stock so above you can see the gauge for Smith-Midland's ROCE against it's prior returns. If you're interested in investigating Smith-Midland's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
On the surface, the trend of ROCE at Smith-Midland doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.7% from 24% 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.
The Bottom Line
We're a bit apprehensive about Smith-Midland because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Since the stock has skyrocketed 135% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you want to know some of the risks facing Smith-Midland we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.
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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