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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. So while Sylvamo (NYSE:SLVM) has a high ROCE right now, lets see what we can decipher from how returns are changing.
What Is Return On Capital Employed (ROCE)?
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. Analysts use this formula to calculate it for Sylvamo:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = US$433m ÷ (US$2.9b - US$695m) (Based on the trailing twelve months to December 2023).
So, Sylvamo has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Forestry industry average of 13%.
In the above chart we have measured Sylvamo's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Sylvamo for free.
What The Trend Of ROCE Can Tell Us
We've noticed that although returns on capital are flat over the last four years, the amount of capital employed in the business has fallen 25% in that same period. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. But we have to give it to Sylvamo because the returns on the capital it is employing are still high in relative terms.
Our Take On Sylvamo's ROCE
It's a shame to see that Sylvamo is effectively shrinking in terms of its capital base. Since the stock has gained an impressive 29% over the last year, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing: We've identified 3 warning signs with Sylvamo (at least 1 which shouldn't be ignored) , and understanding them would certainly be useful.
Sylvamo is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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.