REACT Group (LON:REAT) Shareholders Will Want The ROCE Trajectory To Continue

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Speaking of which, we noticed some great changes in REACT Group's (LON:REAT) returns on capital, so let's have a look.

Understanding 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. To calculate this metric for REACT Group, this is the formula:

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

0.01 = UK£102k ÷ (UK£15m - UK£4.6m) (Based on the trailing twelve months to March 2023).

So, REACT Group has an ROCE of 1.0%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 9.5%.

See our latest analysis for REACT Group

In the above chart we have measured REACT Group'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 REACT Group here for free.

The Trend Of ROCE

The fact that REACT Group is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 1.0% on its capital. Not only that, but the company is utilizing 333% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 32% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line

In summary, it's great to see that REACT Group has managed to break into profitability and is continuing to reinvest in its business. Since the stock has returned a staggering 482% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

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

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.