To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. In light of that, when we looked at SalfaCorp (SNSE:SALFACORP) and its ROCE trend, we weren't exactly thrilled.
Understanding 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. To calculate this metric for SalfaCorp, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = CL$28b ÷ (CL$1.2t - CL$459b) (Based on the trailing twelve months to September 2021).
So, SalfaCorp has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 7.6%.
Above you can see how the current ROCE for SalfaCorp 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 SalfaCorp.
What Can We Tell From SalfaCorp's ROCE Trend?
On the surface, the trend of ROCE at SalfaCorp doesn't inspire confidence. To be more specific, ROCE has fallen from 6.8% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
In summary, despite lower returns in the short term, we're encouraged to see that SalfaCorp is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 20% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
One final note, you should learn about the 3 warning signs we've spotted with SalfaCorp (including 2 which are potentially serious) .
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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.
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