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There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Merit Medical Systems (NASDAQ:MMSI), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Merit Medical Systems, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = US$58m ÷ (US$1.7b - US$186m) (Based on the trailing twelve months to December 2020).
Therefore, Merit Medical Systems has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 9.7%.
Above you can see how the current ROCE for Merit Medical Systems 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 Merit Medical Systems here for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Merit Medical Systems, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.9% from 6.6% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
What We Can Learn From Merit Medical Systems' ROCE
To conclude, we've found that Merit Medical Systems is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 187% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Merit Medical Systems could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
While Merit Medical Systems 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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