Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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 Green Cross Health (NZSE:GXH) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What is 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. Analysts use this formula to calculate it for Green Cross Health:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = NZ$36m ÷ (NZ$374m - NZ$113m) (Based on the trailing twelve months to September 2020).
Therefore, Green Cross Health has an ROCE of 14%. By itself that's a normal return on capital and it's in line with the industry's average returns of 14%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Green Cross Health's ROCE against it's prior returns. If you're interested in investigating Green Cross Health's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Green Cross Health, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 14% from 19% five years ago. However it looks like Green Cross Health might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
The Key Takeaway
To conclude, we've found that Green Cross Health is reinvesting in the business, but returns have been falling. And in the last five years, the stock has given away 53% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
If you want to continue researching Green Cross Health, you might be interested to know about the 1 warning sign that our analysis has discovered.
While Green Cross Health 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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