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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Quest Resource Holding (NASDAQ:QRHC) and its trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Quest Resource Holding, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.042 = US$3.6m ÷ (US$108m - US$23m) (Based on the trailing twelve months to March 2021).
Thus, Quest Resource Holding has an ROCE of 4.2%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 7.6%.
Above you can see how the current ROCE for Quest Resource Holding 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 Quest Resource Holding here for free.
What The Trend Of ROCE Can Tell Us
Quest Resource Holding has broken into the black (profitability) and we're sure it's a sight for sore eyes. The company now earns 4.2% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
On a related note, the company's ratio of current liabilities to total assets has decreased to 21%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.
As discussed above, Quest Resource Holding appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And a remarkable 131% 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.
One more thing to note, we've identified 2 warning signs with Quest Resource Holding and understanding these should be part of your investment process.
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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