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To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think SFL (NYSE:SFL) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 SFL:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.075 = US$184m ÷ (US$3.1b - US$610m) (Based on the trailing twelve months to March 2021).
Thus, SFL has an ROCE of 7.5%. On its own, that's a low figure but it's around the 6.7% average generated by the Oil and Gas industry.
In the above chart we have measured SFL's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering SFL here for free.
How Are Returns Trending?
There hasn't been much to report for SFL's returns and its level of capital employed because both metrics have been steady for the past five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So unless we see a substantial change at SFL in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. That being the case, it makes sense that SFL has been paying out 80% of its earnings to its shareholders. If the company is in fact lacking growth opportunities, that's one of the viable alternatives for the money.
Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 20% of total assets, this reported ROCE would probably be less than7.5% because total capital employed would be higher.The 7.5% ROCE could be even lower if current liabilities weren't 20% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.
The Key Takeaway
We can conclude that in regards to SFL's returns on capital employed and the trends, there isn't much change to report on. And investors appear hesitant that the trends will pick up because the stock has fallen 25% in the last five years. Therefore based on the analysis done in this article, we don't think SFL has the makings of a multi-bagger.
One final note, you should learn about the 4 warning signs we've spotted with SFL (including 1 which makes us a bit uncomfortable) .
While SFL 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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