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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Bodycote (LON:BOY) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Bodycote, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.081 = UK£66m ÷ (UK£1.1b - UK£294m) (Based on the trailing twelve months to December 2020).
So, Bodycote has an ROCE of 8.1%. On its own, that's a low figure but it's around the 8.7% average generated by the Machinery industry.
Above you can see how the current ROCE for Bodycote compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Bodycote.
What The Trend Of ROCE Can Tell Us
In terms of Bodycote's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 15% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
What We Can Learn From Bodycote's ROCE
We're a bit apprehensive about Bodycote because despite more capital being deployed in the business, returns on that capital and sales have both fallen. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 83% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you'd like to know about the risks facing Bodycote, we've discovered 3 warning signs that you should be aware of.
While Bodycote 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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