Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Having said that, while the ROCE is currently high for Knorr-Bremse (ETR:KBX), we aren't jumping out of our chairs because returns are decreasing.
What is 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. 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)
0.22 = €957m ÷ (€7.4b - €3.2b) (Based on the trailing twelve months to September 2021).
Therefore, Knorr-Bremse has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Machinery industry average of 8.5%.
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, you can check out the forecasts from the analysts covering Knorr-Bremse here for free.
The Trend Of ROCE
In terms of Knorr-Bremse's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 33%. However it looks like Knorr-Bremse might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
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.
The Bottom Line
In summary, Knorr-Bremse is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly, the stock has only gained 13% over the last three years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
On a final note, we've found 1 warning sign for Knorr-Bremse that we think you should be aware of.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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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.