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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Magal Security Systems (NASDAQ:MAGS), it didn't seem to tick all of these boxes.
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. Analysts use this formula to calculate it for Magal Security Systems:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.048 = US$4.7m ÷ (US$123m - US$25m) (Based on the trailing twelve months to September 2020).
Thus, Magal Security Systems has an ROCE of 4.8%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 10%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Magal Security Systems' past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
On the surface, the trend of ROCE at Magal Security Systems doesn't inspire confidence. Around five years ago the returns on capital were 10%, but since then they've fallen to 4.8%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
What We Can Learn From Magal Security Systems' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Magal Security Systems have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 18% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing to note, we've identified 1 warning sign with Magal Security Systems and understanding this should be part of your investment process.
While Magal Security Systems isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
If you’re looking to trade Magal Security Systems, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.