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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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So, when we ran our eye over EBOS Group's (NZSE:EBO) trend of ROCE, 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. Analysts use this formula to calculate it for EBOS Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = AU$260m ÷ (AU$3.7b - AU$1.8b) (Based on the trailing twelve months to June 2020).
So, EBOS Group has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Healthcare industry average of 7.5% it's much better.
Above you can see how the current ROCE for EBOS Group 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 EBOS Group here for free.
What The Trend Of ROCE Can Tell Us
While the returns on capital are good, they haven't moved much. Over the past five years, ROCE has remained relatively flat at around 13% and the business has deployed 62% more capital into its operations. Since 13% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
Another thing to note, EBOS Group has a high ratio of current liabilities to total assets of 47%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line On EBOS Group's ROCE
To sum it up, EBOS Group has simply been reinvesting capital steadily, at those decent rates of return. And long term investors would be thrilled with the 127% return they've received 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 1 warning sign for EBOS Group you'll probably want to know about.
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. 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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