There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 investigating StrongPoint (OB:STRO), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
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. The formula for this calculation on StrongPoint is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = kr58m ÷ (kr792m - kr400m) (Based on the trailing twelve months to September 2020).
Therefore, StrongPoint has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 10% generated by the Electronic industry.
Above you can see how the current ROCE for StrongPoint 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.
How Are Returns Trending?
Things have been pretty stable at StrongPoint, with its capital employed and returns on that capital staying somewhat the same for the last five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect StrongPoint to be a multi-bagger going forward. With fewer investment opportunities, it makes sense that StrongPoint has been paying out a decent 56% of its earnings to shareholders. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.On a separate but related note, it's important to know that StrongPoint has a current liabilities to total assets ratio of 51%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
In summary, StrongPoint isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Since the stock has gained an impressive 87% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing to note, we've identified 1 warning sign with StrongPoint and understanding this should be part of your investment process.
While StrongPoint 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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