To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Cloetta (STO:CLA B), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Cloetta:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.08 = kr469m ÷ (kr9.5b - kr3.7b) (Based on the trailing twelve months to March 2021).
So, Cloetta has an ROCE of 8.0%. In absolute terms, that's a low return and it also under-performs the Food industry average of 11%.
In the above chart we have measured Cloetta's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
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 28% in that same period. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. 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 39% of total assets, this reported ROCE would probably be less than8.0% because total capital employed would be higher.The 8.0% ROCE could be even lower if current liabilities weren't 39% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.
The Key Takeaway
It's a shame to see that Cloetta is effectively shrinking in terms of its capital base. And with the stock having returned a mere 14% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
One more thing, we've spotted 2 warning signs facing Cloetta that you might find interesting.
While Cloetta 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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