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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? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at the ROCE trend of Spirent Communications (LON:SPT) we really liked what we saw.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Spirent Communications is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = US$99m ÷ (US$650m - US$155m) (Based on the trailing twelve months to December 2020).
So, Spirent Communications has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.
Check out our latest analysis for Spirent Communications
Above you can see how the current ROCE for Spirent Communications compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Spirent Communications here for free.
What Does the ROCE Trend For Spirent Communications Tell Us?
Spirent Communications is showing promise given that its ROCE is trending up and to the right. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 252% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
What We Can Learn From Spirent Communications' ROCE
In summary, we're delighted to see that Spirent Communications has been able to increase efficiencies and earn higher rates of return on the same amount of capital. And a remarkable 239% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if Spirent Communications can keep these trends up, it could have a bright future ahead.