Returns Are Gaining Momentum At PolyNovo (ASX:PNV)

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Speaking of which, we noticed some great changes in PolyNovo's (ASX:PNV) returns on capital, so let's have a look.

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Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on PolyNovo is:

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

0.075 = AU$6.8m ÷ (AU$113m - AU$23m) (Based on the trailing twelve months to December 2024).

Thus, PolyNovo has an ROCE of 7.5%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 13%.

Check out our latest analysis for PolyNovo

Above you can see how the current ROCE for PolyNovo 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 analyst report for PolyNovo .

The Trend Of ROCE

We're delighted to see that PolyNovo is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 7.5% on its capital. Not only that, but the company is utilizing 235% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 20% of the business, which is more than it was five years ago. 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.

The Key Takeaway

In summary, it's great to see that PolyNovo has managed to break into profitability and is continuing to reinvest in its business. Astute investors may have an opportunity here because the stock has declined 43% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.

If you'd like to know about the risks facing PolyNovo, we've discovered 1 warning sign that you should be aware of.

While PolyNovo 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. 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.