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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Having said that, while the ROCE is currently high for SThree (LON:STEM), we aren't jumping out of our chairs because returns are decreasing.
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)
0.37 = UK£67m ÷ (UK£401m - UK£218m) (Based on the trailing twelve months to November 2021).
Thus, SThree has an ROCE of 37%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.
See our latest analysis for SThree
Above you can see how the current ROCE for SThree 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 SThree.
What Does the ROCE Trend For SThree Tell Us?
In terms of SThree's historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 54% where it was five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, SThree has done well to pay down its current liabilities to 55% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
In Conclusion...
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for SThree. And the stock has followed suit returning a meaningful 50% to shareholders over the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.