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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Dr. Hönle (ETR:HNL), it didn't seem to tick all of these boxes.
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 Dr. Hönle is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = €10.0m ÷ (€165m - €22m) (Based on the trailing twelve months to June 2020).
Thus, Dr. Hönle has an ROCE of 7.0%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 16%.
Check out our latest analysis for Dr. Hönle
In the above chart we have measured Dr. Hönle's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Dr. Hönle here for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Dr. Hönle, we didn't gain much confidence. To be more specific, ROCE has fallen from 26% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Bottom Line
In summary, we're somewhat concerned by Dr. Hönle's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 145% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One final note, you should learn about the 4 warning signs we've spotted with Dr. Hönle (including 1 which shouldn't be ignored) .
While Dr. Hönle may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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This article by Simply Wall St is general in nature. 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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About XTRA:HNL
Dr. Hönle
Engages in the supply of industrial UV technologies and systems in Germany and internationally.
Undervalued with reasonable growth potential.
