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There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Patterson Companies (NASDAQ:PDCO) 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)?
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. To calculate this metric for Patterson Companies, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$241m ÷ (US$2.9b - US$1.2b) (Based on the trailing twelve months to January 2021).
Therefore, Patterson Companies has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Healthcare industry average of 11% it's much better.
In the above chart we have measured Patterson Companies' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Patterson Companies.
How Are Returns Trending?
We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 38% in that same period. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. So if this trend continues, don't be surprised if the business is smaller in a few years time.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 42% of total assets, this reported ROCE would probably be less than15% because total capital employed would be higher.The 15% ROCE could be even lower if current liabilities weren't 42% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.
In summary, Patterson Companies isn't reinvesting funds back into the business and returns aren't growing. And in the last five years, the stock has given away 19% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
Patterson Companies does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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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