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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Pennant Group (NASDAQ:PNTG), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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 Pennant Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.052 = US$20m ÷ (US$469m - US$80m) (Based on the trailing twelve months to June 2020).
Therefore, Pennant Group has an ROCE of 5.2%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 9.8%.
In the above chart we have measured Pennant Group'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.
How Are Returns Trending?
When we looked at the ROCE trend at Pennant Group, we didn't gain much confidence. Over the last two years, returns on capital have decreased to 5.2% from 28% two years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Pennant Group has done well to pay down its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On Pennant Group's ROCE
While returns have fallen for Pennant Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 145% return over the last year, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
One more thing, we've spotted 3 warning signs facing Pennant Group that you might find interesting.
While Pennant Group 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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