To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, Precot (NSE:PRECOT) looks quite promising in regards to its trends of return on capital.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Precot is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = ₹903m ÷ (₹7.6b - ₹2.9b) (Based on the trailing twelve months to June 2021).
Thus, Precot has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Luxury industry average of 12% it's much better.
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're interested in investigating Precot's past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
The trends we've noticed at Precot are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 19%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 93%. So we're very much inspired by what we're seeing at Precot thanks to its ability to profitably reinvest capital.
One more thing to note, Precot has decreased current liabilities to 38% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
The Bottom Line On Precot's ROCE
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Precot has. Since the stock has returned a staggering 479% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Precot does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit unpleasant...
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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.
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