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 UPM-Kymmene Oyj (HEL:UPM), it didn't seem to tick all of these boxes.
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. To calculate this metric for UPM-Kymmene Oyj, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.066 = €891m ÷ (€16b - €2.5b) (Based on the trailing twelve months to March 2021).
Thus, UPM-Kymmene Oyj has an ROCE of 6.6%. In absolute terms, that's a low return but it's around the Forestry industry average of 6.4%.
Above you can see how the current ROCE for UPM-Kymmene Oyj compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering UPM-Kymmene Oyj here for free.
So How Is UPM-Kymmene Oyj's ROCE Trending?
Things have been pretty stable at UPM-Kymmene Oyj, with its capital employed and returns on that capital staying somewhat the same for the last five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect UPM-Kymmene Oyj to be a multi-bagger going forward. That probably explains why UPM-Kymmene Oyj has been paying out 65% of its earnings as dividends to shareholders. If the company is in fact lacking growth opportunities, that's one of the viable alternatives for the money.
The Key Takeaway
In summary, UPM-Kymmene Oyj isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Yet to long term shareholders the stock has gifted them an incredible 148% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
UPM-Kymmene Oyj does have some risks though, and we've spotted 1 warning sign for UPM-Kymmene Oyj that you might be interested in.
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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