Returns On Capital Signal Tricky Times Ahead For Pharmanutra (BIT:PHN)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Having said that, while the ROCE is currently high for Pharmanutra (BIT:PHN), we aren't jumping out of our chairs because returns are decreasing.

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. To calculate this metric for Pharmanutra, this is the formula:

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

0.36 = €15m ÷ (€52m - €11m) (Based on the trailing twelve months to December 2020).

Thus, Pharmanutra has an ROCE of 36%. In absolute terms that's a great return and it's even better than the Personal Products industry average of 9.2%.

View our latest analysis for Pharmanutra

In the above chart we have measured Pharmanutra's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Pharmanutra.

So How Is Pharmanutra's ROCE Trending?

On the surface, the trend of ROCE at Pharmanutra doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 53% where it was five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Pharmanutra has done well to pay down its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. 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

To conclude, we've found that Pharmanutra is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 194% return in the last three years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One final note, you should learn about the 3 warning signs we've spotted with Pharmanutra (including 2 which are a bit unpleasant) .

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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