Did you know there are some financial metrics that can provide clues of a potential 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Reach Subsea (OB:REACH) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. To calculate this metric for Reach Subsea, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.059 = kr11m ÷ (kr479m - kr285m) (Based on the trailing twelve months to June 2020).
Therefore, Reach Subsea has an ROCE of 5.9%. On its own that's a low return, but compared to the average of 4.7% generated by the Energy Services industry, it's much better.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Reach Subsea's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Reach Subsea, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 27% in that same period. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 59% of total assets, this reported ROCE would probably be less than5.9% because total capital employed would be higher.The 5.9% ROCE could be even lower if current liabilities weren't 59% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.
The Key Takeaway
In summary, Reach Subsea isn't reinvesting funds back into the business and returns aren't growing. Since the stock has declined 30% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Reach Subsea has the makings of a multi-bagger.
If you want to know some of the risks facing Reach Subsea we've found 3 warning signs (1 is concerning!) that you should be aware of before investing here.
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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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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