To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after investigating Proto Labs (NYSE:PRLB), we don't think it's current trends fit the mold of a multi-bagger.
What is Return On Capital Employed (ROCE)?
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. To calculate this metric for Proto Labs, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.086 = US$60m ÷ (US$744m - US$50m) (Based on the trailing twelve months to December 2020).
Thus, Proto Labs has an ROCE of 8.6%. In absolute terms, that's a low return but it's around the Machinery industry average of 9.9%.
In the above chart we have measured Proto Labs' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Proto Labs here for free.
The Trend Of ROCE
When we looked at the ROCE trend at Proto Labs, we didn't gain much confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 8.6%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
What We Can Learn From Proto Labs' ROCE
To conclude, we've found that Proto Labs is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 68% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing to note, we've identified 3 warning signs with Proto Labs and understanding them should be part of your investment process.
While Proto Labs 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. 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.
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