If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. So, when we ran our eye over Italtile's (JSE:ITE) trend of ROCE, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Italtile is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.28 = R1.9b ÷ (R8.2b - R1.4b) (Based on the trailing twelve months to December 2020).
Therefore, Italtile has an ROCE of 28%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 19%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Italtile's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Italtile, check out these free graphs here.
What Does the ROCE Trend For Italtile Tell Us?
In terms of Italtile's history of ROCE, it's quite impressive. The company has employed 122% more capital in the last five years, and the returns on that capital have remained stable at 28%. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
The Bottom Line
In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
Italtile does have some risks though, and we've spotted 1 warning sign for Italtile that you might be interested in.
Italtile is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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