What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Knorr-Bremse (ETR:KBX), we don't think it's current trends fit the mold of a multi-bagger.
What is 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 Knorr-Bremse, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = €854m ÷ (€7.5b - €3.2b) (Based on the trailing twelve months to September 2020).
So, Knorr-Bremse has an ROCE of 20%. On its own, that's a standard return, however it's much better than the 7.1% generated by the Machinery industry.
In the above chart we have measured Knorr-Bremse'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 Knorr-Bremse.
What Can We Tell From Knorr-Bremse's ROCE Trend?
When we looked at the ROCE trend at Knorr-Bremse, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 20% from 45% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a separate but related note, it's important to know that Knorr-Bremse has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
We're a bit apprehensive about Knorr-Bremse because despite more capital being deployed in the business, returns on that capital and sales have both fallen. But investors must be expecting an improvement of sorts because over the last yearthe stock has delivered a respectable 35% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you want to continue researching Knorr-Bremse, you might be interested to know about the 2 warning signs that our analysis has discovered.
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.
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