If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Tactile Systems Technology (NASDAQ:TCMD), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Tactile Systems Technology, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.017 = US$2.0m ÷ (US$142m - US$20m) (Based on the trailing twelve months to June 2020).
Thus, Tactile Systems Technology has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 9.6%.
Above you can see how the current ROCE for Tactile Systems Technology compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Tactile Systems Technology.
What The Trend Of ROCE Can Tell Us
In terms of Tactile Systems Technology's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 1.7% from 14% 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.
In summary, despite lower returns in the short term, we're encouraged to see that Tactile Systems Technology is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 39% over the last three years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.
One more thing to note, we've identified 1 warning sign with Tactile Systems Technology and understanding this should be part of your investment process.
While Tactile Systems Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. 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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