What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Virtus Health (ASX:VRT) and its ROCE trend, we weren't exactly thrilled.
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. To calculate this metric for Virtus Health, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.079 = AU$42m ÷ (AU$626m - AU$90m) (Based on the trailing twelve months to June 2020).
So, Virtus Health has an ROCE of 7.9%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.8%.
Above you can see how the current ROCE for Virtus Health compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Virtus Health here for free.
What Does the ROCE Trend For Virtus Health Tell Us?
When we looked at the ROCE trend at Virtus Health, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.9% from 12% five years ago. However it looks like Virtus Health 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 may take some time before the company starts to see any change in earnings from these investments.
The Key Takeaway
To conclude, we've found that Virtus Health is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 7.6% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
One more thing, we've spotted 4 warning signs facing Virtus Health that you might find interesting.
While Virtus Health isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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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