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. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Porvair (LON:PRV) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is 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. The formula for this calculation on Porvair is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.089 = UK£12m ÷ (UK£166m - UK£28m) (Based on the trailing twelve months to November 2020).
Therefore, Porvair has an ROCE of 8.9%. Even though it's in line with the industry average of 8.9%, it's still a low return by itself.
Above you can see how the current ROCE for Porvair 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 Porvair here for free.
How Are Returns Trending?
On the surface, the trend of ROCE at Porvair doesn't inspire confidence. Around five years ago the returns on capital were 13%, but since then they've fallen to 8.9%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
The Bottom Line
To conclude, we've found that Porvair is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 63% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you're still interested in Porvair it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.
While Porvair may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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