If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Sigma Healthcare (ASX:SIG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Sigma Healthcare, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.061 = AU$42m ÷ (AU$1.2b - AU$530m) (Based on the trailing twelve months to July 2021).
So, Sigma Healthcare has an ROCE of 6.1%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 8.3%.
In the above chart we have measured Sigma Healthcare's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
When we looked at the ROCE trend at Sigma Healthcare, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.1% from 17% 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 related note, Sigma Healthcare has decreased its current liabilities to 44% of total assets. So we could link some of this to the decrease in ROCE. 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 44% is still pretty high, so those risks are still somewhat prevalent.
The Bottom Line On Sigma Healthcare's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Sigma Healthcare. These growth trends haven't led to growth returns though, since the stock has fallen 49% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
One more thing, we've spotted 2 warning signs facing Sigma Healthcare that you might find interesting.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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