Talgo (BME:TLGO) Has More To Do To Multiply In Value Going Forward

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after briefly looking over the numbers, we don't think Talgo (BME:TLGO) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Talgo is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.061 = €39m ÷ (€1.0b - €405m) (Based on the trailing twelve months to June 2023).

So, Talgo has an ROCE of 6.1%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 7.8%.

See our latest analysis for Talgo

In the above chart we have measured Talgo'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 Talgo.

What The Trend Of ROCE Can Tell Us

There hasn't been much to report for Talgo's returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. With that in mind, unless investment picks up again in the future, we wouldn't expect Talgo to be a multi-bagger going forward. With fewer investment opportunities, it makes sense that Talgo has been paying out a decent 35% of its earnings to shareholders. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 39% of total assets, this reported ROCE would probably be less than6.1% because total capital employed would be higher.The 6.1% ROCE could be even lower if current liabilities weren't 39% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

The Key Takeaway

In a nutshell, Talgo has been trudging along with the same returns from the same amount of capital over the last five years. And investors appear hesitant that the trends will pick up because the stock has fallen 17% in the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

On a final note, we found 3 warning signs for Talgo (1 is concerning) you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.