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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Inspecs Group (LON:SPEC) and its ROCE trend, we weren't exactly thrilled.
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. Analysts use this formula to calculate it for Inspecs Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0092 = US$2.1m ÷ (US$299m - US$67m) (Based on the trailing twelve months to June 2021).
Thus, Inspecs Group has an ROCE of 0.9%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 10%.
In the above chart we have measured Inspecs Group'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.
So How Is Inspecs Group's ROCE Trending?
When we looked at the ROCE trend at Inspecs Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% over the last four years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Inspecs Group has done well to pay down its current liabilities to 23% of total assets. That could partly explain why the ROCE has dropped. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On Inspecs Group's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Inspecs Group is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 0.6% gain to shareholders who've held over the last year. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.
Inspecs Group does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those can't be ignored...
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.
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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.