If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, Perma-Fix Environmental Services (NASDAQ:PESI) looks quite promising in regards to its trends of return on capital.
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. Analysts use this formula to calculate it for Perma-Fix Environmental Services:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.073 = US$3.4m ÷ (US$79m - US$33m) (Based on the trailing twelve months to December 2020).
So, Perma-Fix Environmental Services has an ROCE of 7.3%. In absolute terms, that's a low return but it's around the Commercial Services industry average of 8.7%.
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 Perma-Fix Environmental Services' past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
We're pretty happy with how the ROCE has been trending at Perma-Fix Environmental Services. The figures show that over the last five years, returns on capital have grown by 373%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 30% 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.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 42% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. And with current liabilities at those levels, that's pretty high.
The Bottom Line
From what we've seen above, Perma-Fix Environmental Services has managed to increase it's returns on capital all the while reducing it's capital base. Since the stock has returned a solid 97% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
On a final note, we've found 1 warning sign for Perma-Fix Environmental Services that we think you should be aware of.
While Perma-Fix Environmental Services isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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