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If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Ergo, when we looked at the ROCE trends at Avery Dennison (NYSE:AVY), we liked what we saw.
Return On Capital Employed (ROCE): What is it?
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 Avery Dennison:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = US$874m ÷ (US$6.1b - US$1.9b) (Based on the trailing twelve months to January 2021).
So, Avery Dennison has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.
Above you can see how the current ROCE for Avery Dennison 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 Avery Dennison here for free.
The Trend Of ROCE
We'd be pretty happy with returns on capital like Avery Dennison. Over the past five years, ROCE has remained relatively flat at around 21% and the business has deployed 55% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.
In short, we'd argue Avery Dennison has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And long term investors would be thrilled with the 194% return they've received over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
Avery Dennison does have some risks though, and we've spotted 2 warning signs for Avery Dennison that you might be interested in.
High returns are a key ingredient to strong performance, so check out our free list ofstocks 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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