If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. That's why when we briefly looked at Pentamaster International's (HKG:1665) ROCE trend, we were very happy with what we saw.
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 Pentamaster International, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = RM106m ÷ (RM617m - RM103m) (Based on the trailing twelve months to September 2020).
Thus, Pentamaster International has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Semiconductor industry average of 7.6%.
Above you can see how the current ROCE for Pentamaster International compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Pentamaster International's ROCE Trending?
Pentamaster International deserves to be commended in regards to it's returns. Over the past five years, ROCE has remained relatively flat at around 21% and the business has deployed 832% more capital into its operations. Now considering ROCE is an attractive 21%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
On a side note, Pentamaster International has done well to reduce current liabilities to 17% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
Our Take On Pentamaster International's ROCE
In short, we'd argue Pentamaster International has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. On top of that, the stock has rewarded shareholders with a remarkable 106% return to those who've held over the last three years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
One final note, you should learn about the 2 warning signs we've spotted with Pentamaster International (including 1 which is a bit concerning) .
Pentamaster International is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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