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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Air Products and Chemicals (NYSE:APD), it didn't seem to tick all of these boxes.
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 Air Products and Chemicals is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.099 = US$2.4b ÷ (US$27b - US$3.4b) (Based on the trailing twelve months to June 2022).
Therefore, Air Products and Chemicals has an ROCE of 9.9%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 12%.
In the above chart we have measured Air Products and Chemicals' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
There are better returns on capital out there than what we're seeing at Air Products and Chemicals. Over the past five years, ROCE has remained relatively flat at around 9.9% and the business has deployed 56% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
What We Can Learn From Air Products and Chemicals' ROCE
As we've seen above, Air Products and Chemicals' returns on capital haven't increased but it is reinvesting in the business. Although the market must be expecting these trends to improve because the stock has gained 73% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
On a final note, we've found 1 warning sign for Air Products and Chemicals that we think you should be aware of.
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.
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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.