Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. That's why when we briefly looked at Schaffer's (ASX:SFC) ROCE trend, we were pretty happy with what we saw.
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. Analysts use this formula to calculate it for Schaffer:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = AU$36m ÷ (AU$376m - AU$61m) (Based on the trailing twelve months to June 2022).
So, Schaffer has an ROCE of 11%. That's a pretty standard return and it's in line with the industry average of 11%.
View our latest analysis for Schaffer
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Schaffer has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
While the current returns on capital are decent, they haven't changed much. The company has consistently earned 11% for the last five years, and the capital employed within the business has risen 148% in that time. 11% is a pretty standard return, and it provides some comfort knowing that Schaffer has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 16% of total assets, is good to see from a business owner's perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.
What We Can Learn From Schaffer's ROCE
To sum it up, Schaffer has simply been reinvesting capital steadily, at those decent rates of return. On top of that, the stock has rewarded shareholders with a remarkable 125% return to those who've held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.