What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think IAG Holdings (HKG:8513) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
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. To calculate this metric for IAG Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.034 = S$758k ÷ (S$31m - S$8.6m) (Based on the trailing twelve months to September 2021).
Thus, IAG Holdings has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 10%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for IAG Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of IAG Holdings, check out these free graphs here.
How Are Returns Trending?
On the surface, the trend of ROCE at IAG Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 54% over the last five years. 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'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.
On a side note, IAG Holdings has done well to pay down its current liabilities to 28% 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
Bringing it all together, while we're somewhat encouraged by IAG Holdings' reinvestment in its own business, we're aware that returns are shrinking. And in the last three years, the stock has given away 41% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
One more thing to note, we've identified 4 warning signs with IAG Holdings and understanding these should be part of your investment process.
While IAG Holdings 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.