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What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Although, when we looked at Select Medical Holdings (NYSE:SEM), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on Select Medical Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.073 = US$463m ÷ (US$7.7b - US$1.3b) (Based on the trailing twelve months to September 2020).
Therefore, Select Medical Holdings has an ROCE of 7.3%. In absolute terms, that's a low return and it also under-performs the Healthcare industry average of 11%.
Above you can see how the current ROCE for Select Medical Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Select Medical Holdings here for free.
How Are Returns Trending?
In terms of Select Medical Holdings' historical ROCE trend, it doesn't exactly demand attention. The company has employed 67% more capital in the last five years, and the returns on that capital have remained stable at 7.3%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
In summary, Select Medical Holdings has simply been reinvesting capital and generating the same low rate of return as before. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 140% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
On a final note, we've found 1 warning sign for Select Medical Holdings that we think you should be aware of.
While Select Medical Holdings 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.
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