What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Hera (BIT:HER), it didn't seem to tick all of these boxes.
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. Analysts use this formula to calculate it for Hera:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.074 = €545m ÷ (€10b - €2.9b) (Based on the trailing twelve months to September 2020).
Thus, Hera has an ROCE of 7.4%. In absolute terms, that's a low return, but it's much better than the Integrated Utilities industry average of 4.8%.
Above you can see how the current ROCE for Hera compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Hera.
How Are Returns Trending?
In terms of Hera's historical ROCE trend, it doesn't exactly demand attention. The company has employed 26% more capital in the last five years, and the returns on that capital have remained stable at 7.4%. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
What We Can Learn From Hera's ROCE
Long story short, while Hera has been reinvesting its capital, the returns that it's generating haven't increased. Although the market must be expecting these trends to improve because the stock has gained 41% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Hera does have some risks though, and we've spotted 2 warning signs for Hera that you might be interested in.
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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