Some Investors May Be Worried About Smith & Nephew's (LON:SN.) Returns On Capital
When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Smith & Nephew (LON:SN.), so let's see why.
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 Smith & Nephew is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.088 = US$682m ÷ (US$10.0b - US$2.3b) (Based on the trailing twelve months to December 2023).
Thus, Smith & Nephew has an ROCE of 8.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.9%.
See our latest analysis for Smith & Nephew
Above you can see how the current ROCE for Smith & Nephew 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 analyst report for Smith & Nephew .
How Are Returns Trending?
In terms of Smith & Nephew's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 15% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Smith & Nephew to turn into a multi-bagger.
Our Take On Smith & Nephew's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. It should come as no surprise then that the stock has fallen 20% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Smith & Nephew does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those can't be ignored...
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.
