Returns On Capital Signal Tricky Times Ahead For SThree (LON:STEM)
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at SThree (LON:STEM), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
Understanding Return On Capital Employed (ROCE)
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. To calculate this metric for SThree, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.33 = UK£73m ÷ (UK£437m - UK£217m) (Based on the trailing twelve months to May 2023).
Therefore, SThree has an ROCE of 33%. That's a fantastic return and not only that, it outpaces the average of 16% earned by companies in a similar industry.
Check out our latest analysis for SThree
In the above chart we have measured SThree'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 SThree here for free.
How Are Returns Trending?
On the surface, the trend of ROCE at SThree doesn't inspire confidence. Historically returns on capital were even higher at 58%, but they have dropped over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, SThree has done well to pay down its current liabilities to 50% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
The Bottom Line On SThree's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that SThree is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 74% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
On a separate note, we've found 1 warning sign for SThree you'll probably want to know about.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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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.
