There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. So when we looked at Beacon Lighting Group (ASX:BLX), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Beacon Lighting Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = AU$51m ÷ (AU$304m - AU$88m) (Based on the trailing twelve months to December 2020).
Therefore, Beacon Lighting Group has an ROCE of 24%. On its own, that's a very good return and it's on par with the returns earned by companies in a similar industry.
Above you can see how the current ROCE for Beacon Lighting Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Beacon Lighting Group.
So How Is Beacon Lighting Group's ROCE Trending?
When we looked at the ROCE trend at Beacon Lighting Group, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 48% where it was five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Beacon Lighting Group has done well to pay down its current liabilities to 29% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line On Beacon Lighting Group's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Beacon Lighting Group. These trends are starting to be recognized by investors since the stock has delivered a 15% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
One final note, you should learn about the 2 warning signs we've spotted with Beacon Lighting Group (including 1 which doesn't sit too well with us) .
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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