If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 investigating Solid State (LON:SOLI), we don't think it's current trends fit the mold of a multi-bagger.
What is 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 Solid State, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = UK£4.0m ÷ (UK£37m - UK£11m) (Based on the trailing twelve months to September 2020).
So, Solid State has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 7.2% it's much better.
In the above chart we have measured Solid State's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Solid State here for free.
So How Is Solid State's ROCE Trending?
On the surface, the trend of ROCE at Solid State doesn't inspire confidence. Around five years ago the returns on capital were 22%, but since then they've fallen to 15%. 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 may take some time before the company starts to see any change in earnings from these investments.On a related note, Solid State has decreased its current liabilities to 29% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
Our Take On Solid State's ROCE
To conclude, we've found that Solid State is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 45% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Solid State does have some risks though, and we've spotted 1 warning sign for Solid State that you might be interested in.
While Solid State 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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Solid State plc designs and manufactures electronic equipment and supplies the value added electronic components and materials in the United Kingdom, rest of Europe, Asia, North America, and internationally.
Reasonable growth potential with adequate balance sheet.