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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, while the ROCE is currently high for Shriro Holdings (ASX:SHM), we aren't jumping out of our chairs because returns are decreasing.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Shriro Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = AU$16m ÷ (AU$106m - AU$33m) (Based on the trailing twelve months to June 2022).
Thus, Shriro Holdings has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 9.1% earned by companies in a similar industry.
See our latest analysis for Shriro Holdings
Historical performance is a great place to start when researching a stock so above you can see the gauge for Shriro Holdings' ROCE against it's prior returns. If you'd like to look at how Shriro Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Shriro Holdings Tell Us?
When we looked at the ROCE trend at Shriro Holdings, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 37%. However it looks like Shriro Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by Shriro Holdings' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 20% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Shriro Holdings has the makings of a multi-bagger.
On a final note, we've found 2 warning signs for Shriro Holdings that we think you should be aware of.