What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 briefly looking over the numbers, we don't think Regis Healthcare (ASX:REG) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 Regis Healthcare, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.093 = AU$43m ÷ (AU$1.8b - AU$1.3b) (Based on the trailing twelve months to June 2020).
Thus, Regis Healthcare has an ROCE of 9.3%. On its own, that's a low figure but it's around the 7.9% average generated by the Healthcare industry.
Above you can see how the current ROCE for Regis Healthcare 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.
So How Is Regis Healthcare's ROCE Trending?
On the surface, the trend of ROCE at Regis Healthcare doesn't inspire confidence. Over the last five years, returns on capital have decreased to 9.3% from 37% five years ago. However it looks like Regis Healthcare might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.Another thing to note, Regis Healthcare has a high ratio of current liabilities to total assets of 75%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
Our Take On Regis Healthcare's ROCE
Bringing it all together, while we're somewhat encouraged by Regis Healthcare's reinvestment in its own business, we're aware that returns are shrinking. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 77% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
Like most companies, Regis Healthcare does come with some risks, and we've found 4 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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