To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Speaking of which, we noticed some great changes in Hiolle Industries' (EPA:ALHIO) returns on capital, so let's have a look.
What is Return On Capital Employed (ROCE)?
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 Hiolle Industries is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = €6.5m ÷ (€73m - €32m) (Based on the trailing twelve months to June 2019).
Thus, Hiolle Industries has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 7.9% generated by the Machinery industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Hiolle Industries' ROCE against it's prior returns. If you're interested in investigating Hiolle Industries' past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
Investors would be pleased with what's happening at Hiolle Industries. The data shows that returns on capital have increased substantially over the last five years to 16%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 34%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.On a side note, Hiolle Industries' current liabilities are still rather high at 44% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Key Takeaway
In summary, it's great to see that Hiolle Industries can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 13% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
On a final note, we found 3 warning signs for Hiolle Industries (1 is a bit concerning) you should be aware of.
While Hiolle Industries isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. 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.
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