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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Sun Messe (TYO:7883) so let's look a bit deeper.
Understanding 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 Sun Messe, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0067 = JP¥91m ÷ (JP¥18b - JP¥4.3b) (Based on the trailing twelve months to September 2020).
So, Sun Messe has an ROCE of 0.7%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 7.7%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Sun Messe's ROCE against it's prior returns. If you're interested in investigating Sun Messe's past further, check out this free graph of past earnings, revenue and cash flow.
So How Is Sun Messe's ROCE Trending?
Shareholders will be relieved that Sun Messe has broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 0.7%, which is always encouraging. While returns have increased, the amount of capital employed by Sun Messe has remained flat over the period. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
The Key Takeaway
In summary, we're delighted to see that Sun Messe has been able to increase efficiencies and earn higher rates of return on the same amount of capital. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. With that in mind, we believe the promising trends warrant this stock for further investigation.
One more thing, we've spotted 2 warning signs facing Sun Messe that you might find interesting.
While Sun Messe isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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