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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Vista Outdoor (NYSE:VSTO) and its trend of ROCE, we really liked what we saw.
Understanding 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 Vista Outdoor is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = US$274m ÷ (US$1.8b - US$371m) (Based on the trailing twelve months to March 2021).
Thus, Vista Outdoor has an ROCE of 20%. That's a pretty standard return and it's in line with the industry average of 20%.
In the above chart we have measured Vista Outdoor's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Vista Outdoor.
What Does the ROCE Trend For Vista Outdoor Tell Us?
Vista Outdoor has not disappointed in regards to ROCE growth. The data shows that returns on capital have increased by 92% over the trailing five years. The company is now earning US$0.2 per dollar of capital employed. Speaking of capital employed, the company is actually utilizing 46% 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.
In summary, it's great to see that Vista Outdoor has been able to turn things around and earn higher returns on lower amounts of capital. And since the stock has fallen 26% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
On a final note, we found 2 warning signs for Vista Outdoor (1 can't be ignored) you should be aware of.
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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