There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Nestlé (VTX:NESN) 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 who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Nestlé, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = CHF15b ÷ (CHF139b - CHF40b) (Based on the trailing twelve months to December 2021).
Therefore, Nestlé has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 9.8% it's much better.
In the above chart we have measured Nestlé's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Nestlé.
What Can We Tell From Nestlé's ROCE Trend?
There hasn't been much to report for Nestlé's returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. With that in mind, unless investment picks up again in the future, we wouldn't expect Nestlé to be a multi-bagger going forward. This probably explains why Nestlé is paying out 60% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
The Bottom Line On Nestlé's ROCE
In summary, Nestlé isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Although the market must be expecting these trends to improve because the stock has gained 71% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Nestlé (of which 1 shouldn't be ignored!) 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.