Yahoo Finance Smith & Nephew's (LON:SN.) Returns On Capital Not Reflecting Well On The Business
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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Smith & Nephew (LON:SN.), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Smith & Nephew:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.081 = US$665m ÷ (US$10.0b - US$1.7b) (Based on the trailing twelve months to December 2022).
So, Smith & Nephew has an ROCE of 8.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.4%.
Check out our latest analysis for Smith & Nephew
In the above chart we have measured Smith & Nephew'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.
What Can We Tell From Smith & Nephew's ROCE Trend?
In terms of Smith & Nephew's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 13% over the last five years. However it looks like Smith & Nephew might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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.
What We Can Learn From Smith & Nephew's ROCE
Bringing it all together, while we're somewhat encouraged by Smith & Nephew's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 1.9% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.
Smith & Nephew does come with some risks though, we found 5 warning signs in our investment analysis, and 2 of those are a bit concerning...
While Smith & Nephew isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
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