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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Ergo, when we looked at the ROCE trends at Codan (ASX:CDA), we liked what we saw.
What Is 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. To calculate this metric for Codan, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = AU$138m ÷ (AU$591m - AU$122m) (Based on the trailing twelve months to June 2022).
Therefore, Codan has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Electronic industry average of 15%.
Above you can see how the current ROCE for Codan 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 Codan here for free.
What Can We Tell From Codan's ROCE Trend?
We'd be pretty happy with returns on capital like Codan. The company has consistently earned 29% for the last five years, and the capital employed within the business has risen 171% in that time. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. You'll see this when looking at well operated businesses or favorable business models.
What We Can Learn From Codan's ROCE
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 the stock has done incredibly well with a 219% return over the last five years, so long term investors are no doubt ecstatic with that result. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Codan (of which 1 makes us a bit uncomfortable!) that you should know about.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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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.
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