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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Having said that, from a first glance at Sensata Technologies Holding (NYSE:ST) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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. The formula for this calculation on Sensata Technologies Holding is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = US$381m ÷ (US$7.6b - US$626m) (Based on the trailing twelve months to September 2020).
Thus, Sensata Technologies Holding has an ROCE of 5.5%. Ultimately, that's a low return and it under-performs the Electrical industry average of 8.3%.
Above you can see how the current ROCE for Sensata Technologies Holding 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 Sensata Technologies Holding.
How Are Returns Trending?
When we looked at the ROCE trend at Sensata Technologies Holding, we didn't gain much confidence. Around five years ago the returns on capital were 9.7%, but since then they've fallen to 5.5%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
What We Can Learn From Sensata Technologies Holding's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Sensata Technologies Holding have fallen, meanwhile the business is employing more capital than it was five years ago. Despite the concerning underlying trends, the stock has actually gained 11% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
If you'd like to know more about Sensata Technologies Holding, we've spotted 4 warning signs, and 1 of them shouldn't be ignored.
While Sensata Technologies Holding 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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