There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Although, when we looked at Indus Gas (LON:INDI), it didn't seem to tick all of these boxes.
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. Analysts use this formula to calculate it for Indus Gas:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = US$48m ÷ (US$1.1b - US$44m) (Based on the trailing twelve months to September 2020).
Therefore, Indus Gas has an ROCE of 4.4%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 5.8%.
Above you can see how the current ROCE for Indus Gas compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Indus Gas.
What Can We Tell From Indus Gas' ROCE Trend?
When we looked at the ROCE trend at Indus Gas, we didn't gain much confidence. Around five years ago the returns on capital were 5.8%, but since then they've fallen to 4.4%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Bottom Line
We're a bit apprehensive about Indus Gas because despite more capital being deployed in the business, returns on that capital and sales have both fallen. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 80% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Indus Gas does have some risks though, and we've spotted 1 warning sign for Indus Gas that you might be interested in.
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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