If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Dromeas (ATH:DROME) so let's look a bit deeper.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on Dromeas is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.027 = €1.4m ÷ (€65m - €14m) (Based on the trailing twelve months to December 2020).
Therefore, Dromeas has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 9.9%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Dromeas' ROCE against it's prior returns. If you're interested in investigating Dromeas' past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
Dromeas has broken into the black (profitability) and we're sure it's a sight for sore eyes. The company now earns 2.7% on its capital, because five years ago it was incurring losses. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. Because in the end, a business can only get so efficient.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 21% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
The Key Takeaway
As discussed above, Dromeas appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.
One final note, you should learn about the 2 warning signs we've spotted with Dromeas (including 1 which doesn't sit too well with us) .
While Dromeas 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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