If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Sharps Compliance (NASDAQ:SMED) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. To calculate this metric for Sharps Compliance, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.022 = US$910k ÷ (US$54m - US$13m) (Based on the trailing twelve months to June 2020).
Thus, Sharps Compliance has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 9.6%.
In the above chart we have measured Sharps Compliance'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 Sharps Compliance here for free.
What Does the ROCE Trend For Sharps Compliance Tell Us?
When we looked at the ROCE trend at Sharps Compliance, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.2% from 5.1% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
Our Take On Sharps Compliance's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Sharps Compliance. However, despite the promising trends, the stock has fallen 14% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
Sharps Compliance does have some risks, we noticed 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
While Sharps Compliance 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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