To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. However, after briefly looking over the numbers, we don't think Mondi (LON:MNDI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. To calculate this metric for Mondi, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = €892m ÷ (€8.4b - €1.4b) (Based on the trailing twelve months to December 2020).
Thus, Mondi has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Forestry industry average of 6.4% it's much better.
In the above chart we have measured Mondi's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Mondi.
What Does the ROCE Trend For Mondi Tell Us?
On the surface, the trend of ROCE at Mondi doesn't inspire confidence. Over the last five years, returns on capital have decreased to 13% from 18% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
What We Can Learn From Mondi's ROCE
Bringing it all together, while we're somewhat encouraged by Mondi's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 71% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing to note, we've identified 2 warning signs with Mondi and understanding them should be part of your investment process.
While Mondi isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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Mondi plc engages in the manufacture and sale of packaging and paper products in Africa, Western Europe, Emerging Europe, Russia, North America, South America, Asia, and Australia.
Flawless balance sheet with outstanding track record and pays a dividend.