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System1 Group (LON:SYS1) Could Be Struggling To Allocate Capital

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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Having said that, while the ROCE is currently high for System1 Group (LON:SYS1), we aren't jumping out of our chairs because returns are decreasing.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for System1 Group:

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

0.29 = UK£3.2m ÷ (UK£17m - UK£6.1m) (Based on the trailing twelve months to March 2021).

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Thus, System1 Group has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Media industry average of 8.6%.

View our latest analysis for System1 Group

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Above you can see how the current ROCE for System1 Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for System1 Group.

What Can We Tell From System1 Group's ROCE Trend?

When we looked at the ROCE trend at System1 Group, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 56% where it was five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

Our Take On System1 Group's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for System1 Group have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 31% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Like most companies, System1 Group does come with some risks, and we've found 2 warning signs that you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.