Nanosonics (ASX:NAN) May Have Issues Allocating Its Capital
What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Although, when we looked at Nanosonics (ASX:NAN), it didn't seem to tick all of these boxes.
Understanding 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 Nanosonics:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.082 = AU$12m ÷ (AU$171m - AU$20m) (Based on the trailing twelve months to December 2021).
So, Nanosonics has an ROCE of 8.2%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 12%.
See our latest analysis for Nanosonics
Above you can see how the current ROCE for Nanosonics compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Nanosonics here for free.
The Trend Of ROCE
On the surface, the trend of ROCE at Nanosonics doesn't inspire confidence. Over the last five years, returns on capital have decreased to 8.2% from 15% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
What We Can Learn From Nanosonics' ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Nanosonics is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 17% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
On a separate note, we've found 1 warning sign for Nanosonics you'll probably want to know about.
While Nanosonics may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.
