If you're looking for a multi-bagger, there's a few things to 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 Retech Technology (ASX:RTE) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. Analysts use this formula to calculate it for Retech Technology:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = CN¥51m ÷ (CN¥446m - CN¥90m) (Based on the trailing twelve months to June 2020).
So, Retech Technology has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Consumer Services industry average of 8.9% it's much better.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Retech Technology has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Retech Technology Tell Us?
On the surface, the trend of ROCE at Retech Technology doesn't inspire confidence. Around three years ago the returns on capital were 28%, but since then they've fallen to 14%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
Our Take On Retech Technology's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Retech Technology is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 36% over the last three years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
On a final note, we found 2 warning signs for Retech Technology (1 is a bit unpleasant) you should be aware of.
While Retech Technology 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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