If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, EuroDry (NASDAQ:EDRY) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on EuroDry is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.018 = US$1.6m ÷ (US$108m - US$18m) (Based on the trailing twelve months to March 2021).
So, EuroDry has an ROCE of 1.8%. In absolute terms, that's a low return and it also under-performs the Shipping industry average of 6.2%.
In the above chart we have measured EuroDry's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for EuroDry.
So How Is EuroDry's ROCE Trending?
Shareholders will be relieved that EuroDry has broken into profitability. The company now earns 1.8% on its capital, because four years ago it was incurring losses. While returns have increased, the amount of capital employed by EuroDry has remained flat over the period. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 17% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
What We Can Learn From EuroDry's ROCE
To sum it up, EuroDry is collecting higher returns from the same amount of capital, and that's impressive. And with the stock having performed exceptionally well over the last year, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for EuroDry (of which 1 shouldn't be ignored!) that you should know about.
While EuroDry isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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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