What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Multi-Chem's (SGX:AWZ) returns on capital, so let's have a look.
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. To calculate this metric for Multi-Chem, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = S$19m ÷ (S$273m - S$141m) (Based on the trailing twelve months to December 2020).
Therefore, Multi-Chem has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 9.4% generated by the Electronic industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Multi-Chem's ROCE against it's prior returns. If you'd like to look at how Multi-Chem has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Multi-Chem Tell Us?
We like the trends that we're seeing from Multi-Chem. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 14%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 32%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
On a separate but related note, it's important to know that Multi-Chem 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.
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Multi-Chem has. Since the stock has returned a staggering 343% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
If you want to continue researching Multi-Chem, you might be interested to know about the 1 warning sign that our analysis has discovered.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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