Here's What To Make Of Karelia Tobacco's (ATH:KARE) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Karelia Tobacco (ATH:KARE), we don't think it's current trends fit the mold of a multi-bagger.

What is 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 Karelia Tobacco, this is the formula:

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

0.16 = €87m ÷ (€628m - €87m) (Based on the trailing twelve months to September 2020).

Thus, Karelia Tobacco has an ROCE of 16%. That's a relatively normal return on capital, and it's around the 15% generated by the Tobacco industry.

Check out our latest analysis for Karelia Tobacco

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Karelia Tobacco has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Karelia Tobacco's ROCE Trend?

On the surface, the trend of ROCE at Karelia Tobacco doesn't inspire confidence. Over the last five years, returns on capital have decreased to 16% from 25% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Karelia Tobacco has done well to pay down its current liabilities to 14% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Bottom Line On Karelia Tobacco's ROCE

Bringing it all together, while we're somewhat encouraged by Karelia Tobacco's reinvestment in its own business, we're aware that returns are shrinking. And investors may be recognizing these trends since the stock has only returned a total of 38% to shareholders over the last five years. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

On a final note, we've found 1 warning sign for Karelia Tobacco that we think you should be aware of.

While Karelia Tobacco 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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This article by Simply Wall St is general in nature. 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.
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