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There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Nanosonics' (ASX:NAN) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Nanosonics, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = AU$7.9m ÷ (AU$150m - AU$15m) (Based on the trailing twelve months to December 2020).
So, Nanosonics has an ROCE of 5.8%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 8.8%.
Above you can see how the current ROCE for Nanosonics 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 Nanosonics here for free.
What The Trend Of ROCE Can Tell Us
We're delighted to see that Nanosonics is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 5.8% on its capital. Not only that, but the company is utilizing 200% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 9.7%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Nanosonics has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
The Bottom Line On Nanosonics' ROCE
In summary, it's great to see that Nanosonics has managed to break into profitability and is continuing to reinvest in its business. And a remarkable 115% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Like most companies, Nanosonics does come with some risks, and we've found 1 warning sign that you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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