PolyNovo (ASX:PNV) Is Looking To Continue Growing Its Returns On Capital

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at PolyNovo (ASX:PNV) 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. To calculate this metric for PolyNovo, this is the formula:

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

0.033 = AU$905k ÷ (AU$37m - AU$9.0m) (Based on the trailing twelve months to December 2021).

So, PolyNovo has an ROCE of 3.3%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 12%.

See our latest analysis for PolyNovo

In the above chart we have measured PolyNovo's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering PolyNovo here for free.

The Trend Of ROCE

PolyNovo has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 3.3% on its capital. In addition to that, PolyNovo is employing 98% 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 side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 24% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

In Conclusion...

To the delight of most shareholders, PolyNovo has now broken into profitability. And a remarkable 569% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if PolyNovo can keep these trends up, it could have a bright future ahead.

If you'd like to know about the risks facing PolyNovo, we've discovered 2 warning signs that you should be aware of.

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. 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.