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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Farmmi (NASDAQ:FAMI) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
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 Farmmi is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.06 = US$2.4m ÷ (US$48m - US$7.9m) (Based on the trailing twelve months to March 2021).
Therefore, Farmmi has an ROCE of 6.0%. In absolute terms, that's a low return and it also under-performs the Food industry average of 9.8%.
View 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'd like to look at how Farmmi has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
In terms of Farmmi's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.0% from 44% five years ago. 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 related note, Farmmi has decreased its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.
What We Can Learn From Farmmi's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Farmmi. Despite these promising trends, the stock has collapsed 87% 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.
One more thing: We've identified 3 warning signs with Farmmi (at least 2 which don't sit too well with us) , and understanding these would certainly be useful.
While Farmmi may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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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About NasdaqCM:FAMI
Farmmi
Through its subsidiaries, engages in processing and sale of agricultural products in China, the United States, Japan, Canada, Europe, Korea, and the Middle East.
Moderate with adequate balance sheet.
