Here's What To Make Of Pacific Smiles Group's (ASX:PSQ) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after investigating Pacific Smiles Group (ASX:PSQ), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Pacific Smiles Group, this is the formula:

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

0.11 = AU$13m ÷ (AU$148m - AU$32m) (Based on the trailing twelve months to June 2020).

Therefore, Pacific Smiles Group has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 7.8% generated by the Healthcare industry.

Check out our latest analysis for Pacific Smiles Group

In the above chart we have measured Pacific Smiles Group'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 Pacific Smiles Group here for free.

What Can We Tell From Pacific Smiles Group's ROCE Trend?

In terms of Pacific Smiles Group's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 28% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

Our Take On Pacific Smiles Group's ROCE

To conclude, we've found that Pacific Smiles Group is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 45% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Like most companies, Pacific Smiles Group does come with some risks, and we've found 2 warning signs that you should be aware of.

While Pacific Smiles Group 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. 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.
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