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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Smith Douglas Homes (NYSE:SDHC), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Smith Douglas Homes:

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

0.27 = US$119m ÷ (US$476m - US$41m) (Based on the trailing twelve months to December 2024).

So, Smith Douglas Homes has an ROCE of 27%.  That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.

View our latest analysis for Smith Douglas Homes NYSE:SDHC Return on Capital Employed April 2nd 2025

Above you can see how the current ROCE for Smith Douglas Homes 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 Smith Douglas Homes  for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Smith Douglas Homes, we didn't gain much confidence. Historically returns on capital were even higher at 53%, but they have dropped over the last three years. 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.

On a side note, Smith Douglas Homes has done well to pay down its current liabilities to 8.6% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Story Continues

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Smith Douglas Homes. However, despite the promising trends, the stock has fallen 30% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing: We've identified  2 warning signs  with Smith Douglas Homes (at least 1 which doesn't sit too well with us)  , and understanding these would certainly be useful.

Smith Douglas Homes 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.

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