Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Veidekke (OB:VEI) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Veidekke, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = kr883m ÷ (kr20b - kr12b) (Based on the trailing twelve months to September 2020).
So, Veidekke has an ROCE of 10%. That's a pretty standard return and it's in line with the industry average of 10%.
Above you can see how the current ROCE for Veidekke compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
When we looked at the ROCE trend at Veidekke, we didn't gain much confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 10%. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a related note, Veidekke has decreased its current liabilities to 58% 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. Keep in mind 58% is still pretty high, so those risks are still somewhat prevalent.
The Bottom Line
In summary, Veidekke is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors may be recognizing these trends since the stock has only returned a total of 40% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
If you'd like to know about the risks facing Veidekke, we've discovered 1 warning sign that you should be aware of.
While Veidekke may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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