Investors Met With Slowing Returns on Capital At Patterson Companies (NASDAQ:PDCO)

There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after briefly looking over the numbers, we don't think Patterson Companies (NASDAQ:PDCO) 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?

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. To calculate this metric for Patterson Companies, this is the formula:

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

0.14 = US$235m ÷ (US$2.8b - US$1.0b) (Based on the trailing twelve months to July 2022).

So, Patterson Companies has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Healthcare industry average of 11% it's much better.

Our analysis indicates that PDCO is potentially undervalued!

Above you can see how the current ROCE for Patterson Companies 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 Patterson Companies here for free.

What Can We Tell From Patterson Companies' ROCE Trend?

Over the past five years, Patterson Companies' ROCE has remained relatively flat while the business is using 34% less capital than before. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. So if this trend continues, don't be surprised if the business is smaller in a few years time.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 38% of total assets, this reported ROCE would probably be less than14% because total capital employed would be higher.The 14% ROCE could be even lower if current liabilities weren't 38% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

Our Take On Patterson Companies' ROCE

In summary, Patterson Companies isn't reinvesting funds back into the business and returns aren't growing. And investors appear hesitant that the trends will pick up because the stock has fallen 18% in the last five years. Therefore based on the analysis done in this article, we don't think Patterson Companies has the makings of a multi-bagger.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Patterson Companies (of which 2 are concerning!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.