Returns On Capital Are Showing Encouraging Signs At Severfield (LON:SFR)
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'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. With that in mind, we've noticed some promising trends at Severfield (LON:SFR) so let's look a bit deeper.
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If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Severfield:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = UK£32m ÷ (UK£388m - UK£133m) (Based on the trailing twelve months to September 2024).
Therefore, Severfield has an ROCE of 12%. In absolute terms, that's a pretty standard return but compared to the Construction industry average it falls behind.
See our latest analysis for Severfield
In the above chart we have measured Severfield's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Severfield .
The trends we've noticed at Severfield are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 12%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 25%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 34% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
In summary, it's great to see that Severfield can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Astute investors may have an opportunity here because the stock has declined 34% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.
One final note, you should learn about the 4 warning signs we've spotted with Severfield (including 2 which shouldn't be ignored) .
While Severfield may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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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