Headlam Group (LON:HEAD) Has Some Way To Go To Become A Multi-Bagger

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. However, after briefly looking over the numbers, we don't think Headlam Group (LON:HEAD) 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)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Headlam Group, this is the formula:

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

0.16 = UK£40m ÷ (UK£463m - UK£210m) (Based on the trailing twelve months to June 2022).

Therefore, Headlam Group has an ROCE of 16%. By itself that's a normal return on capital and it's in line with the industry's average returns of 16%.

Check out the opportunities and risks within the GB Retail Distributors industry.

In the above chart we have measured Headlam Group'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 Headlam Group.

The Trend Of ROCE

Over the past five years, Headlam Group's ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So don't be surprised if Headlam Group doesn't end up being a multi-bagger in a few years time. On top of that you'll notice that Headlam Group has been paying out a large portion (60%) of earnings in the form of dividends to shareholders. These mature businesses typically have reliable earnings and not many places to reinvest them, so the next best option is to put the earnings into shareholders pockets.

Another thing to note, Headlam Group has a high ratio of current liabilities to total assets of 45%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Headlam Group's ROCE

We can conclude that in regards to Headlam Group's returns on capital employed and the trends, there isn't much change to report on. And in the last five years, the stock has given away 27% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Headlam Group does have some risks, we noticed 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

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.