To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Quartix Holdings (LON:QTX), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
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. To calculate this metric for Quartix Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.26 = UK£5.7m ÷ (UK£31m - UK£8.6m) (Based on the trailing twelve months to December 2020).
Thus, Quartix Holdings has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Software industry average of 7.5%.
In the above chart we have measured Quartix Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
In terms of Quartix Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 40% where it was five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
To conclude, we've found that Quartix Holdings is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 91% 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.
Like most companies, Quartix Holdings does come with some risks, and we've found 1 warning sign that you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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