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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Scott Technology (NZSE:SCT), we don't think it's current trends fit the mold of a multi-bagger.
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 Scott Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = NZ$13m ÷ (NZ$211m - NZ$97m) (Based on the trailing twelve months to February 2022).
Thus, Scott Technology has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Machinery industry average of 11%.
View our latest analysis for Scott Technology
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're interested in investigating Scott Technology's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
Over the past five years, Scott Technology's ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So don't be surprised if Scott Technology doesn't end up being a multi-bagger in a few years time.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 46% of total assets, this reported ROCE would probably be less than12% because total capital employed would be higher.The 12% ROCE could be even lower if current liabilities weren't 46% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.