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Capital Allocation Trends At Select Medical Holdings (NYSE:SEM) Aren't Ideal

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. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Select Medical Holdings (NYSE:SEM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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. To calculate this metric for Select Medical Holdings, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.057 = US$361m ÷ (US$7.6b - US$1.2b) (Based on the trailing twelve months to September 2022).

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Thus, Select Medical Holdings has an ROCE of 5.7%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 10%.

Check out our latest analysis for Select Medical Holdings

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In the above chart we have measured Select Medical Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Select Medical Holdings here for free.

So How Is Select Medical Holdings' ROCE Trending?

When we looked at the ROCE trend at Select Medical Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.7% from 7.4% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Our Take On Select Medical Holdings' ROCE

Bringing it all together, while we're somewhat encouraged by Select Medical Holdings' reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 45% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Select Medical Holdings does have some risks, we noticed 3 warning signs (and 1 which is significant) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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