Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. With that in mind, we've noticed some promising trends at L.S. Starrett (NYSE:SCX) so let's look a bit deeper.
What Is 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 L.S. Starrett:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$23m ÷ (US$194m - US$39m) (Based on the trailing twelve months to September 2022).
Thus, L.S. Starrett has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 11% generated by the Machinery industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for L.S. Starrett's ROCE against it's prior returns. If you're interested in investigating L.S. Starrett's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For L.S. Starrett Tell Us?
L.S. Starrett has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 1,149% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
To bring it all together, L.S. Starrett has done well to increase the returns it's generating from its capital employed. Since the stock has only returned 2.5% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.
On a final note, we've found 2 warning signs for L.S. Starrett that we think you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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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