If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. With that in mind, we've noticed some promising trends at Nanosonics (ASX:NAN) so let's look a bit deeper.
What is 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. The formula for this calculation on Nanosonics is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = AU$7.9m ÷ (AU$150m - AU$15m) (Based on the trailing twelve months to December 2020).
Therefore, Nanosonics has an ROCE of 5.8%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 8.8%.
In the above chart we have measured Nanosonics' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
The fact that Nanosonics is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 5.8% which is a sight for sore eyes. In addition to that, Nanosonics is employing 200% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
On a related note, the company's ratio of current liabilities to total assets has decreased to 9.7%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.
To the delight of most shareholders, Nanosonics has now broken into profitability. Since the stock has returned a solid 86% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. In light of that, we think it's worth looking further into this stock because if Nanosonics can keep these trends up, it could have a bright future ahead.
Nanosonics does have some risks though, and we've spotted 1 warning sign for Nanosonics that you might be interested in.
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.
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