If you’re not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we’ll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don’t think Momentum Group (STO:MMGR B) has the makings of a multi-bagger going forward, but let’s have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Momentum Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.068 = kr381m ÷ (kr7.6b – kr2.0b) (Based on the trailing twelve months to June 2020).
Therefore, Momentum Group has an ROCE of 6.8%. In absolute terms, that’s a low return and it also under-performs the Trade Distributors industry average of 15%.
In the above chart we have measured Momentum Group’s prior ROCE against its prior performance, but the future is arguably more important. If you’d like to see what analysts are forecasting going forward, you should check out our free report for Momentum Group.
What Does the ROCE Trend For Momentum Group Tell Us?
On the surface, the trend of ROCE at Momentum Group doesn’t inspire confidence. Over the last five years, returns on capital have decreased to 6.8% from 11% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.On a side note, Momentum Group has done well to pay down its current liabilities to 27% 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. Since the business is basically funding more of its operations with it’s own money, you could argue this has made the business less efficient at generating ROCE.
Our Take On Momentum Group’s ROCE
While returns have fallen for Momentum Group in recent times, we’re encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 71% over the last three years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
If you want to know some of the risks facing Momentum Group we’ve found 3 warning signs (1 shouldn’t be ignored!) that you should be aware of before investing here.
While Momentum Group 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. 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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