There Are Reasons To Feel Uneasy About IMI's (LON:IMI) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at IMI (LON:IMI) and its ROCE trend, we weren't exactly thrilled.

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 IMI, this is the formula:

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

0.19 = UK£330m ÷ (UK£2.5b - UK£819m) (Based on the trailing twelve months to December 2022).

Therefore, IMI has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 13% generated by the Machinery industry.

See our latest analysis for IMI

In the above chart we have measured IMI's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering IMI here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at IMI doesn't inspire confidence. Over the last five years, returns on capital have decreased to 19% from 25% five years ago. However it looks like IMI might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

What We Can Learn From IMI's ROCE

In summary, IMI is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 54% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing, we've spotted 1 warning sign facing IMI that you might find interesting.

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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.