There are a few key trends to look for if we want to identify the next multi-bagger. 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. Having said that, while the ROCE is currently high for Relatech (BIT:RLT), 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. The formula for this calculation on Relatech is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = €3.9m ÷ (€26m - €6.6m) (Based on the trailing twelve months to June 2020).
Therefore, Relatech has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.
Above you can see how the current ROCE for Relatech compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Relatech here for free.
So How Is Relatech's ROCE Trending?
When we looked at the ROCE trend at Relatech, we didn't gain much confidence. While it's comforting that the ROCE is high, three years ago it was 47%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.On a related note, Relatech has decreased its current liabilities to 25% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.
What We Can Learn From Relatech's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Relatech is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 182% return over the last year, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Relatech (of which 1 is concerning!) that you should know about.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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