If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. So when we looked at NEXTDC (ASX:NXT) and its trend of ROCE, we really liked what we saw.
What is Return On Capital Employed (ROCE)?
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. The formula for this calculation on NEXTDC is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.014 = AU$36m ÷ (AU$2.6b - AU$51m) (Based on the trailing twelve months to December 2020).
Therefore, NEXTDC has an ROCE of 1.4%. In absolute terms, that's a low return and it also under-performs the IT industry average of 10%.
Above you can see how the current ROCE for NEXTDC 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 The Trend Of ROCE Can Tell Us
While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The data shows that returns on capital have increased substantially over the last five years to 1.4%. Basically the business is earning more per dollar of capital invested and in addition to that, 413% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
What We Can Learn From NEXTDC's ROCE
To sum it up, NEXTDC has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation that compares the share price and estimated value.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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