There are a few key trends to look for if we want to identify the next multi-bagger. 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. However, after investigating Switch (NYSE:SWCH), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Switch:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.048 = US$96m ÷ (US$2.1b - US$104m) (Based on the trailing twelve months to December 2020).
Therefore, Switch has an ROCE of 4.8%. Ultimately, that's a low return and it under-performs the IT industry average of 11%.
In the above chart we have measured Switch's 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 Can We Tell From Switch's ROCE Trend?
In terms of Switch's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 4.8% from 13% 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.
Our Take On Switch's 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 Switch. In light of this, the stock has only gained 20% over the last three years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
Like most companies, Switch does come with some risks, and we've found 1 warning sign that you should be aware of.
While Switch 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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