To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Air Products and Chemicals (NYSE:APD) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
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 Air Products and Chemicals, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.095 = US$2.3b ÷ (US$27b - US$2.6b) (Based on the trailing twelve months to December 2021).
Thus, Air Products and Chemicals has an ROCE of 9.5%. On its own, that's a low figure but it's around the 11% average generated by the Chemicals industry.
Above you can see how the current ROCE for Air Products and Chemicals 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 Air Products and Chemicals here for free.
What Can We Tell From Air Products and Chemicals' ROCE Trend?
On the surface, the trend of ROCE at Air Products and Chemicals doesn't inspire confidence. To be more specific, ROCE has fallen from 12% over the last five years. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
What We Can Learn From Air Products and Chemicals' ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Air Products and Chemicals. Furthermore the stock has climbed 93% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
One more thing to note, we've identified 2 warning signs with Air Products and Chemicals and understanding these should be part of your investment process.
While Air Products and Chemicals isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.