To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. And in light of that, the trends we're seeing at Spirent Communications' (LON:SPT) look very promising so lets take a look.
Understanding 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 Spirent Communications, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = US$101m ÷ (US$625m - US$156m) (Based on the trailing twelve months to June 2021).
So, Spirent Communications has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 8.3% earned by companies in a similar industry.
In the above chart we have measured Spirent Communications' 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?
Spirent Communications has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 208% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
As discussed above, Spirent Communications appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And a remarkable 243% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if Spirent Communications can keep these trends up, it could have a bright future ahead.
Spirent Communications does have some risks though, and we've spotted 1 warning sign for Spirent Communications that you might be interested in.
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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