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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in ScanSource's (NASDAQ:SCSC) returns on capital, so let's have a look.
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 ScanSource, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$122m ÷ (US$1.9b - US$814m) (Based on the trailing twelve months to June 2022).
So, ScanSource has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 12% generated by the Electronic industry.
Above you can see how the current ROCE for ScanSource 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 ScanSource.
How Are Returns Trending?
ScanSource's ROCE growth is quite impressive. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 24% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
Another thing to note, ScanSource has a high ratio of current liabilities to total assets of 42%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line On ScanSource's ROCE
To sum it up, ScanSource is collecting higher returns from the same amount of capital, and that's impressive. And since the stock has fallen 34% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.
One more thing, we've spotted 1 warning sign facing ScanSource that you might find interesting.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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.
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