Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. That's why when we briefly looked at Santova's (JSE:SNV) ROCE trend, we were very happy with 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. Analysts use this formula to calculate it for Santova:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = R153m ÷ (R1.2b - R503m) (Based on the trailing twelve months to August 2021).
So, Santova has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.
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'd like to look at how Santova has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
We'd be pretty happy with returns on capital like Santova. The company has employed 61% more capital in the last five years, and the returns on that capital have remained stable at 22%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.
On a side note, Santova has done well to reduce current liabilities to 42% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously. Although because current liabilities are still 42%, some of that risk is still prevalent.
What We Can Learn From Santova's ROCE
In short, we'd argue Santova has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. Therefore it's no surprise that shareholders have earned a respectable 81% return if they held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
On a separate note, we've found 2 warning signs for Santova you'll probably want to know about.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.