There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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 briefly looking over the numbers, we don't think Transpaco (JSE:TPC) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What is 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 Transpaco:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = R133m ÷ (R1.3b - R366m) (Based on the trailing twelve months to December 2020).
So, Transpaco has an ROCE of 14%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Packaging industry average of 12%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Transpaco's ROCE against it's prior returns. If you're interested in investigating Transpaco's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Transpaco, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 14% from 23% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by Transpaco's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 24% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
Transpaco does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those shouldn't be ignored...
While Transpaco 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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