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Cyanotech (NASDAQ:CYAN) Might Have The Makings Of A Multi-Bagger

·3 min read

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 on that note, Cyanotech (NASDAQ:CYAN) looks quite promising in regards to its trends of return on capital.

Understanding 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. The formula for this calculation on Cyanotech is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.021 = US$545k ÷ (US$31m - US$5.8m) (Based on the trailing twelve months to June 2021).

So, Cyanotech has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Personal Products industry average of 19%.

Check out our latest analysis for Cyanotech

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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 Cyanotech has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Cyanotech Tell Us?

Shareholders will be relieved that Cyanotech has broken into profitability. The company now earns 2.2% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.

In Conclusion...

As discussed above, Cyanotech appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Astute investors may have an opportunity here because the stock has declined 18% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.

One more thing to note, we've identified 2 warning signs with Cyanotech and understanding them should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.