There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Virco Mfg (NASDAQ:VIRC), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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. The formula for this calculation on Virco Mfg is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.013 = US$1.3m ÷ (US$134m - US$30m) (Based on the trailing twelve months to April 2021).
Therefore, Virco Mfg has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 7.8%.
Above you can see how the current ROCE for Virco Mfg compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Virco Mfg here for free.
The Trend Of ROCE
When we looked at the ROCE trend at Virco Mfg, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.3% from 9.3% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a related note, Virco Mfg has decreased its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line
We're a bit apprehensive about Virco Mfg because despite more capital being deployed in the business, returns on that capital and sales have both fallen. And, the stock has remained flat over the last five years, so investors don't seem too impressed either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing: We've identified 2 warning signs with Virco Mfg (at least 1 which is concerning) , and understanding these would certainly be useful.
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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.
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