What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. So, when we ran our eye over Greggs' (LON:GRG) trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What Is It?
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 Greggs, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = UK£153m ÷ (UK£859m - UK£209m) (Based on the trailing twelve months to July 2022).
Thus, Greggs has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 9.2% earned by companies in a similar industry.
See our latest analysis for Greggs
Above you can see how the current ROCE for Greggs 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 Greggs here for free.
So How Is Greggs' ROCE Trending?
Greggs deserves to be commended in regards to it's returns. The company has consistently earned 23% for the last five years, and the capital employed within the business has risen 121% in that time. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
The Key Takeaway
In short, we'd argue Greggs has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. Therefore it's no surprise that shareholders have earned a respectable 58% return if they held 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, we've spotted 1 warning sign facing Greggs that you might find interesting.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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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.
About LSE:GRG
Adequate balance sheet average dividend payer.
