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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. 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.
Understanding Return On Capital Employed (ROCE)
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 Patterson Companies is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = US$214m ÷ (US$2.8b - US$1.1b) (Based on the trailing twelve months to April 2021).
Therefore, Patterson Companies has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Healthcare industry average of 12%.
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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Patterson Companies' ROCE Trend?
We're a bit concerned with the trends, because the business is applying 38% less capital than it was five years ago and returns on that capital have stayed flat. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. 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 40% of total assets, this reported ROCE would probably be less than13% because total capital employed would be higher.The 13% ROCE could be even lower if current liabilities weren't 40% 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.
Overall, we're not ecstatic to see Patterson Companies reducing the amount of capital it employs in the business. Since the stock has declined 21% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
Patterson Companies does have some risks, we noticed 3 warning signs (and 2 which can't be ignored) we think you should know about.
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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