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If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Looking at SThree (LON:STEM), it does have a high ROCE right now, but lets see how returns are trending.
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 SThree is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.31 = UK£77m ÷ (UK£468m - UK£223m) (Based on the trailing twelve months to May 2024).
So, SThree has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 17%.
View our latest analysis for SThree
In the above chart we have measured SThree'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 SThree for free.
What Can We Tell From SThree's ROCE Trend?
On the surface, the trend of ROCE at SThree doesn't inspire confidence. Historically returns on capital were even higher at 59%, but they have dropped over the last five years. 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 side note, SThree has done well to pay down its current liabilities to 48% of total assets. That could partly explain why the ROCE has dropped. 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. Keep in mind 48% is still pretty high, so those risks are still somewhat prevalent.
Our Take On SThree's ROCE
Bringing it all together, while we're somewhat encouraged by SThree'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 17% 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.