If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Sigma Healthcare (ASX:SIG), it didn't seem to tick all of these boxes.
What Is 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 Sigma Healthcare is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.053 = AU$37m ÷ (AU$1.1b - AU$391m) (Based on the trailing twelve months to July 2023).
So, Sigma Healthcare has an ROCE of 5.3%. In absolute terms, that's a low return and it also under-performs the Healthcare industry average of 7.2%.
In the above chart we have measured Sigma Healthcare's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Sigma Healthcare's ROCE Trending?
When we looked at the ROCE trend at Sigma Healthcare, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.3% from 13% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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 related note, Sigma Healthcare has decreased its current liabilities to 36% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Sigma Healthcare's reinvestment in its own business, we're aware that returns are shrinking. And investors may be recognizing these trends since the stock has only returned a total of 30% to shareholders over the last five years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.
On a final note, we've found 1 warning sign for Sigma Healthcare that we think you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.