If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating IDH Development (WSE:IDH), we don't think it's current trends fit the mold of a multi-bagger.
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. The formula for this calculation on IDH Development is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = zł7.9m ÷ (zł93m - zł33m) (Based on the trailing twelve months to March 2021).
Therefore, IDH Development has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Construction industry average of 12%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating IDH Development's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
On the surface, the trend of ROCE at IDH Development doesn't inspire confidence. To be more specific, ROCE has fallen from 23% over the last two years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 35%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 13%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
The Bottom Line On IDH Development's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that IDH Development is reinvesting for growth and has higher sales as a result. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for IDH Development (of which 1 makes us a bit uncomfortable!) that you should know about.
While IDH Development 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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