Returns At PolyNovo (ASX:PNV) Are On The Way Up

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in PolyNovo's (ASX:PNV) returns on capital, so let's have a look.

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

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)

0.02 = AU$540k ÷ (AU$35m - AU$7.8m) (Based on the trailing twelve months to June 2022).

Therefore, PolyNovo has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 9.8%.

See 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 report on analyst forecasts for the company.

What Does the ROCE Trend For PolyNovo Tell Us?

PolyNovo has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 2.0% which is a sight for sore eyes. In addition to that, PolyNovo is employing 143% more capital than previously which is expected of a company that's 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. Essentially the business now has suppliers or short-term creditors funding about 22% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line

Overall, PolyNovo gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has returned a staggering 459% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

One more thing to note, we've identified 1 warning sign with PolyNovo and understanding this should be part of your investment process.

While PolyNovo isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.