There Are Reasons To Feel Uneasy About Neogen's (NASDAQ:NEOG) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating Neogen (NASDAQ:NEOG), we don't think it's current trends fit the mold of a multi-bagger.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Neogen is:

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

0.092 = US$77m ÷ (US$880m - US$46m) (Based on the trailing twelve months to February 2021).

Therefore, Neogen has an ROCE of 9.2%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.7%.

See our latest analysis for Neogen

In the above chart we have measured Neogen's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Neogen here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Neogen, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 9.2% from 14% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

What We Can Learn From Neogen's ROCE

To conclude, we've found that Neogen is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 125% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing, we've spotted 1 warning sign facing Neogen that you might find interesting.

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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