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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at Smart Metering Systems (LON:SMS), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
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 Smart Metering Systems:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.041 = UK£23m ÷ (UK£619m - UK£61m) (Based on the trailing twelve months to June 2022).
So, Smart Metering Systems has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 8.1%.
Check out our latest analysis for Smart Metering Systems
Above you can see how the current ROCE for Smart Metering Systems 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 Smart Metering Systems.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Smart Metering Systems, we didn't gain much confidence. To be more specific, ROCE has fallen from 11% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, Smart Metering Systems has decreased its current liabilities to 9.8% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
Our Take On Smart Metering Systems' ROCE
While returns have fallen for Smart Metering Systems in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends are starting to be recognized by investors since the stock has delivered a 2.7% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.