Yahoo Finance SDI (ASX:SDI) Could Be Struggling To Allocate Capital
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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think SDI (ASX:SDI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. To calculate this metric for SDI, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = AU$9.4m ÷ (AU$95m - AU$11m) (Based on the trailing twelve months to December 2021).
Thus, SDI has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 12% generated by the Medical Equipment industry.
See our latest analysis for SDI
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of SDI, check out these free graphs here.
What Can We Tell From SDI's ROCE Trend?
When we looked at the ROCE trend at SDI, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% over the last five 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
What We Can Learn From SDI'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 SDI. And the stock has followed suit returning a meaningful 56% to shareholders over the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
One more thing, we've spotted 2 warning signs facing SDI that you might find interesting.
While SDI isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
