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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Exchange Income (TSE:EIF) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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. The formula for this calculation on Exchange Income is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.054 = CA$112m ÷ (CA$2.4b - CA$319m) (Based on the trailing twelve months to September 2020).
So, Exchange Income has an ROCE of 5.4%. Even though it's in line with the industry average of 5.4%, it's still a low return by itself.
Above you can see how the current ROCE for Exchange Income 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 Does the ROCE Trend For Exchange Income Tell Us?
We weren't thrilled with the trend because Exchange Income's ROCE has reduced by 33% over the last five years, while the business employed 95% more capital. That being said, Exchange Income raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Exchange Income probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.
Our Take On Exchange Income's ROCE
Bringing it all together, while we're somewhat encouraged by Exchange Income's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 123% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Exchange Income (of which 1 doesn't sit too well with us!) that you should know about.
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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