If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Republic Services (NYSE:RSG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper 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. The formula for this calculation on Republic Services is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.087 = US$1.8b ÷ (US$23b - US$2.3b) (Based on the trailing twelve months to December 2020).
Thus, Republic Services has an ROCE of 8.7%. On its own, that's a low figure but it's around the 7.4% average generated by the Commercial Services industry.
In the above chart we have measured Republic Services' 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.
What Does the ROCE Trend For Republic Services Tell Us?
Over the past five years, Republic Services' ROCE and capital employed have both remained mostly flat. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect Republic Services to be a multi-bagger going forward. This probably explains why Republic Services is paying out 43% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
In summary, Republic Services isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 149% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
One more thing to note, we've identified 1 warning sign with Republic Services and understanding this should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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