What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Polaris (NYSE:PII) we aren’t jumping out of our chairs at how returns are trending, but let’s have a deeper look.
What is Return On Capital Employed (ROCE)?
For those that aren’t sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Polaris is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.15 = US$356m ÷ (US$4.3b – US$1.9b) (Based on the trailing twelve months to June 2020).
So, Polaris has an ROCE of 15%. In absolute terms, that’s a pretty normal return, and it’s somewhat close to the Leisure industry average of 17%.
Above you can see how the current ROCE for Polaris compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
When we looked at the ROCE trend at Polaris, we didn’t gain much confidence. Over the last five years, returns on capital have decreased to 15% from 52% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.On a side note, Polaris’ current liabilities are still rather high at 44% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it’s not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From Polaris’ ROCE
Bringing it all together, while we’re somewhat encouraged by Polaris’ reinvestment in its own business, we’re aware that returns are shrinking. And in the last five years, the stock has given away 13% so the market doesn’t look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don’t think Polaris has the makings of a multi-bagger.
If you’d like to know more about Polaris, we’ve spotted 3 warning signs, and 1 of them can’t be ignored.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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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