Rafako (WSE:RFK) Is Experiencing Growth In Returns On Capital

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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So on that note, Rafako (WSE:RFK) looks quite promising in regards to its trends of return on capital.

What Is 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 Rafako is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.19 = zł42m ÷ (zł633m - zł411m) (Based on the trailing twelve months to March 2022).

Thus, Rafako has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 9.3% it's much better.

Check out our latest analysis for Rafako

Historical performance is a great place to start when researching a stock so above you can see the gauge for Rafako's ROCE against it's prior returns. If you're interested in investigating Rafako's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

We're pretty happy with how the ROCE has been trending at Rafako. The figures show that over the last five years, returns on capital have grown by 139%. The company is now earning zł0.2 per dollar of capital employed. Speaking of capital employed, the company is actually utilizing 58% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

Another thing to note, Rafako has a high ratio of current liabilities to total assets of 65%. 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.

The Key Takeaway

From what we've seen above, Rafako has managed to increase it's returns on capital all the while reducing it's capital base. Astute investors may have an opportunity here because the stock has declined 68% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

One more thing: We've identified 4 warning signs with Rafako (at least 1 which shouldn't be ignored) , and understanding them would certainly be useful.

While Rafako 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.