Returns On Capital At Smart Metering Systems (LON:SMS) Paint A Concerning Picture
If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Smart Metering Systems (LON:SMS), it didn't seem to tick all of these boxes.
What is 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 Smart Metering Systems is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = UK£22m ÷ (UK£633m - UK£58m) (Based on the trailing twelve months to December 2021).
Therefore, Smart Metering Systems has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 9.1%.
Check out our latest analysis for Smart Metering Systems
Above you can see how the current ROCE for Smart Metering Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Smart Metering Systems.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Smart Metering Systems, we didn't gain much confidence. To be more specific, ROCE has fallen from 13% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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, Smart Metering Systems has done well to pay down its current liabilities to 9.2% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
Our Take On Smart Metering Systems' ROCE
To conclude, we've found that Smart Metering Systems is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 63% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Smart Metering Systems does have some risks, we noticed 4 warning signs (and 1 which can't be ignored) we think you should know about.
While Smart Metering Systems 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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