To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. In light of that, when we looked at Merit Medical Systems (NASDAQ:MMSI) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Merit Medical Systems is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.051 = US$73m ÷ (US$1.6b - US$211m) (Based on the trailing twelve months to June 2021).
Thus, Merit Medical Systems has an ROCE of 5.1%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 8.9%.
Above you can see how the current ROCE for Merit Medical Systems 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 Merit Medical Systems here for free.
What Does the ROCE Trend For Merit Medical Systems Tell Us?
The returns on capital haven't changed much for Merit Medical Systems in recent years. The company has consistently earned 5.1% for the last five years, and the capital employed within the business has risen 96% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
The Key Takeaway
As we've seen above, Merit Medical Systems' returns on capital haven't increased but it is reinvesting in the business. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 198% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing to note, we've identified 1 warning sign with Merit Medical Systems and understanding it should be part of your investment process.
While Merit Medical Systems 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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