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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'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. So on that note, Slater and Gordon (ASX:SGH) looks quite promising in regards to its trends of return on capital.
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. To calculate this metric for Slater and Gordon, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.048 = AU$17m ÷ (AU$444m - AU$84m) (Based on the trailing twelve months to June 2022).
Therefore, Slater and Gordon has an ROCE of 4.8%. Even though it's in line with the industry average of 5.2%, it's still a low return by itself.
Check out our latest analysis for Slater and Gordon
Historical performance is a great place to start when researching a stock so above you can see the gauge for Slater and Gordon's ROCE against it's prior returns. If you'd like to look at how Slater and Gordon has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Slater and Gordon's ROCE Trend?
Slater and Gordon has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 4.8% on its capital. In addition to that, Slater and Gordon is employing 98% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
On a related note, the company's ratio of current liabilities to total assets has decreased to 19%, which basically reduces it's funding from the likes of short-term creditors or suppliers. This tells us that Slater and Gordon has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
The Bottom Line
Long story short, we're delighted to see that Slater and Gordon's reinvestment activities have paid off and the company is now profitable. Although the company may be facing some issues elsewhere since the stock has plunged 81% in the last five years. In any case, we believe the economic trends of this company are positive and looking into the stock further could prove rewarding.