- Oops!Something went wrong.Please try again later.
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. That's why when we briefly looked at Eltek's (NASDAQ:ELTK) ROCE trend, we were pretty happy with what we saw.
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. The formula for this calculation on Eltek is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$3.0m ÷ (US$35m - US$9.7m) (Based on the trailing twelve months to March 2021).
Thus, Eltek has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 10% generated by the Electronic industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Eltek's ROCE against it's prior returns. If you're interested in investigating Eltek's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
While the current returns on capital are decent, they haven't changed much. The company has consistently earned 12% for the last five years, and the capital employed within the business has risen 89% in that time. Since 12% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 28% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
To sum it up, Eltek has simply been reinvesting capital steadily, at those decent rates of return. However, over the last five years, the stock has only delivered a 10% return to shareholders who held over that period. So because of the trends we're seeing, we'd recommend looking further into this stock to see if it has the makings of a multi-bagger.
One more thing, we've spotted 3 warning signs facing Eltek that you might find interesting.
While Eltek 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.