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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. So, when we ran our eye over Luceco's (LON:LUCE) trend of ROCE, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Luceco:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = UK£38m ÷ (UK£203m - UK£71m) (Based on the trailing twelve months to December 2021).
Therefore, Luceco has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Electrical industry average of 13%.
In the above chart we have measured Luceco'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.
What Does the ROCE Trend For Luceco Tell Us?
Luceco deserves to be commended in regards to it's returns. The company has consistently earned 29% for the last five years, and the capital employed within the business has risen 193% in that time. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 35% 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.
Our Take On Luceco's ROCE
In summary, we're delighted to see that Luceco has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. However, despite the favorable fundamentals, the stock has fallen 44% over the last five years, so there might be an opportunity here for astute investors. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.
On a final note, we've found 2 warning signs for Luceco that we think you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.