Electrocomponents (LON:ECM) Has More To Do To Multiply In Value Going Forward

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. That's why when we briefly looked at Electrocomponents' (LON:ECM) ROCE trend, we were pretty happy with what we saw.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Electrocomponents:

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

0.14 = UK£167m ÷ (UK£1.8b - UK£631m) (Based on the trailing twelve months to March 2021).

So, Electrocomponents has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 13% generated by the Trade Distributors industry.

See our latest analysis for Electrocomponents

Above you can see how the current ROCE for Electrocomponents 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 Electrocomponents.

What Does the ROCE Trend For Electrocomponents Tell Us?

The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has employed 84% more capital in the last five years, and the returns on that capital have remained stable at 14%. Since 14% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 34% of total assets, is good to see from a business owner's perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.

Our Take On Electrocomponents' ROCE

To sum it up, Electrocomponents has simply been reinvesting capital steadily, at those decent rates of return. And long term investors would be thrilled with the 343% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One more thing to note, we've identified 1 warning sign with Electrocomponents and understanding it should be part of your investment process.

While Electrocomponents 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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