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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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Aristocrat Leisure (ASX:ALL), it didn't seem to tick all of these boxes.
What is 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. Analysts use this formula to calculate it for Aristocrat Leisure:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.077 = AU$528m ÷ (AU$7.9b - AU$1.0b) (Based on the trailing twelve months to September 2020).
Therefore, Aristocrat Leisure has an ROCE of 7.7%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.7%.
In the above chart we have measured Aristocrat Leisure's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Aristocrat Leisure Tell Us?
When we looked at the ROCE trend at Aristocrat Leisure, we didn't gain much confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 7.7%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
Our Take On Aristocrat Leisure's ROCE
To conclude, we've found that Aristocrat Leisure is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 255% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
One more thing: We've identified 2 warning signs with Aristocrat Leisure (at least 1 which is significant) , and understanding them would certainly be useful.
While Aristocrat Leisure may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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