Investors Could Be Concerned With Sigma Healthcare's (ASX:SIG) Returns On Capital
Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Sigma Healthcare (ASX:SIG), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Sigma Healthcare is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = AU$34m ÷ (AU$1.2b - AU$524m) (Based on the trailing twelve months to January 2021).
So, Sigma Healthcare has an ROCE of 5.0%. In absolute terms, that's a low return and it also under-performs the Healthcare industry average of 11%.
Check out our latest analysis for Sigma Healthcare
In the above chart we have measured Sigma Healthcare'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 Sigma Healthcare here for free.
So How Is Sigma Healthcare's ROCE Trending?
When we looked at the ROCE trend at Sigma Healthcare, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a side note, Sigma Healthcare's current liabilities are still rather high at 43% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line
To conclude, we've found that Sigma Healthcare is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 34% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
On a final note, we've found 1 warning sign for Sigma Healthcare that we think you should be aware of.
While Sigma Healthcare may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
