To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Speaking of which, we noticed some great changes in Telephone and Data Systems' (NYSE:TDS) returns on capital, so let's have a look.
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. Analysts use this formula to calculate it for Telephone and Data Systems:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = US$319m ÷ (US$13b - US$963m) (Based on the trailing twelve months to March 2021).
Thus, Telephone and Data Systems has an ROCE of 2.6%. On its own, that's a low figure but it's around the 2.5% average generated by the Wireless Telecom industry.
Above you can see how the current ROCE for Telephone and Data Systems 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 Telephone and Data Systems here for free.
So How Is Telephone and Data Systems' ROCE Trending?
While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The data shows that returns on capital have increased substantially over the last five years to 2.6%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 47%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
What We Can Learn From Telephone and Data Systems' ROCE
In summary, it's great to see that Telephone and Data Systems can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Considering the stock has delivered 6.3% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So with that in mind, we think the stock deserves further research.
One final note, you should learn about the 3 warning signs we've spotted with Telephone and Data Systems (including 2 which are concerning) .
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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