To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. That's why when we briefly looked at Carborundum Universal's (NSE:CARBORUNIV) ROCE trend, we were pretty happy with what we saw.
Return On Capital Employed (ROCE): What is it?
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 Carborundum Universal, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = ₹3.7b ÷ (₹27b - ₹4.7b) (Based on the trailing twelve months to March 2021).
So, Carborundum Universal has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 12% generated by the Machinery industry.
In the above chart we have measured Carborundum Universal's 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.
What The Trend Of ROCE Can Tell Us
While the current returns on capital are decent, they haven't changed much. Over the past five years, ROCE has remained relatively flat at around 16% and the business has deployed 65% more capital into its operations. Since 16% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 17% of total assets, is good to see from a business owner's perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.
The Bottom Line
The main thing to remember is that Carborundum Universal has proven its ability to continually reinvest at respectable rates of return. On top of that, the stock has rewarded shareholders with a remarkable 171% return to those who've held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
One more thing, we've spotted 2 warning signs facing Carborundum Universal that you might find interesting.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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