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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. So, when we ran our eye over Demant's (CPH:DEMANT) trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Demant is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = kr.3.1b ÷ (kr.24b - kr.9.5b) (Based on the trailing twelve months to June 2021).
Thus, Demant has an ROCE of 22%. In absolute terms that's a very respectable return and compared to the Medical Equipment industry average of 21% it's pretty much on par.
In the above chart we have measured Demant'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 Demant here for free.
The Trend Of ROCE
It's hard not to be impressed by Demant's returns on capital. Over the past five years, ROCE has remained relatively flat at around 22% and the business has deployed 50% more capital into its operations. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If Demant can keep this up, we'd be very optimistic about its future.
On a separate but related note, it's important to know that Demant has a current liabilities to total assets ratio of 40%, 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From Demant's ROCE
In summary, we're delighted to see that Demant has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. On top of that, the stock has rewarded shareholders with a remarkable 167% return to those who've held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
Like most companies, Demant does come with some risks, and we've found 1 warning sign that you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.