Farmmi (NASDAQ:FAMI) Will Be Hoping To Turn Its Returns On Capital Around

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. However, after briefly looking over the numbers, we don't think Farmmi (NASDAQ:FAMI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What is it?

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 Farmmi is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.018 = US$2.9m ÷ (US$166m - US$4.1m) (Based on the trailing twelve months to September 2021).

Thus, Farmmi has an ROCE of 1.8%. In absolute terms, that's a low return and it also under-performs the Food industry average of 10.0%.

See our latest analysis for Farmmi

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 want to delve into the historical earnings, revenue and cash flow of Farmmi, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Farmmi, we didn't gain much confidence. Around five years ago the returns on capital were 39%, but since then they've fallen to 1.8%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Farmmi has done well to pay down its current liabilities to 2.5% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

While returns have fallen for Farmmi in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Despite these promising trends, the stock has collapsed 95% over the last three years, so there could be other factors hurting the company's prospects. Therefore, we'd suggest researching the stock further to uncover more about the business.

If you want to know some of the risks facing Farmmi we've found 5 warning signs (3 are potentially serious!) that you should be aware of before investing here.

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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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.