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. 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. In light of that, when we looked at Mercury Systems (NASDAQ:MRCY) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on Mercury Systems is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.066 = US$97m ÷ (US$1.6b - US$126m) (Based on the trailing twelve months to July 2020).
Therefore, Mercury Systems has an ROCE of 6.6%. Ultimately, that's a low return and it under-performs the Aerospace & Defense industry average of 9.5%.
Above you can see how the current ROCE for Mercury Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Mercury Systems here for free.
The Trend Of ROCE
There are better returns on capital out there than what we're seeing at Mercury Systems. The company has employed 320% more capital in the last five years, and the returns on that capital have remained stable at 6.6%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
The Key Takeaway
As we've seen above, Mercury Systems' returns on capital haven't increased but it is reinvesting in the business. Yet to long term shareholders the stock has gifted them an incredible 352% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you'd like to know about the risks facing Mercury Systems, we've discovered 1 warning sign that you should be aware of.
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.
This article by Simply Wall St is general in nature. 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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