To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don't think Verizon Communications (NYSE:VZ) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
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 Verizon Communications:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$32b ÷ (US$346b - US$39b) (Based on the trailing twelve months to March 2021).
Therefore, Verizon Communications has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 12% generated by the Telecom industry.
Above you can see how the current ROCE for Verizon Communications 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 Verizon Communications here for free.
What Can We Tell From Verizon Communications' ROCE Trend?
When we looked at the ROCE trend at Verizon Communications, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
The Bottom Line
In summary, Verizon Communications is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And with the stock having returned a mere 28% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Verizon Communications (of which 1 doesn't sit too well with us!) that you should know about.
While Verizon Communications may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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