Key Tronic's (NASDAQ:KTCC) Returns On Capital Not Reflecting Well On The Business

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Key Tronic (NASDAQ:KTCC) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Key Tronic is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.035 = US$8.8m ÷ (US$391m - US$142m) (Based on the trailing twelve months to October 2021).

Thus, Key Tronic has an ROCE of 3.5%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 9.8%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Key Tronic's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Key Tronic, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

In terms of Key Tronic's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.5% from 7.3% 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. If these investments prove successful, this can bode very well for long term stock performance.

In Conclusion...

While returns have fallen for Key Tronic in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 17% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Key Tronic does have some risks, we noticed 4 warning signs (and 2 which are a bit unpleasant) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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