Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Hornby's (LON:HRN) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
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. To calculate this metric for Hornby, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = UK£1.2m ÷ (UK£54m - UK£7.9m) (Based on the trailing twelve months to March 2022).
Thus, Hornby has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Leisure industry average of 20%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Hornby's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Hornby, check out these free graphs here.
The Trend Of ROCE
The fact that Hornby is now generating some pre-tax profits from its prior investments is very encouraging. About five years ago the company was generating losses but things have turned around because it's now earning 2.6% on its capital. Not only that, but the company is utilizing 55% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
The Bottom Line On Hornby's ROCE
Overall, Hornby gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Given the stock has declined 18% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.
One more thing, we've spotted 1 warning sign facing Hornby that you might find interesting.
While Hornby 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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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.
Hornby PLC, through its subsidiaries, engages in the design, development, sourcing, and distribution of hobby and interactive products in the United Kingdom, the United State, Spain, Italy, and rest of Europe.
Adequate balance sheet and slightly overvalued.