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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. And in light of that, the trends we're seeing at Spectra Systems' (LON:SPSY) look very promising so lets take a look.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Spectra Systems:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = US$9.0m ÷ (US$37m - US$6.5m) (Based on the trailing twelve months to June 2023).
So, Spectra Systems has an ROCE of 29%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.
See our latest analysis for Spectra Systems
In the above chart we have measured Spectra Systems' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Spectra Systems.
What The Trend Of ROCE Can Tell Us
We like the trends that we're seeing from Spectra Systems. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 29%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 20%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
The Bottom Line
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Spectra Systems has. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Spectra Systems does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit concerning...