Did you know there are some financial metrics that can provide clues of a potential 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. Having said that, from a first glance at Renishaw (LON:RSW) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is Return On Capital Employed (ROCE)?
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 Renishaw, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.098 = UK£66m ÷ (UK£766m - UK£94m) (Based on the trailing twelve months to June 2020).
So, Renishaw has an ROCE of 9.8%. In absolute terms, that's a low return, but it's much better than the Electronic industry average of 7.2%.
Above you can see how the current ROCE for Renishaw 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 Renishaw here for free.
The Trend Of ROCE
On the surface, the trend of ROCE at Renishaw doesn't inspire confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 9.8%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
In summary, we're somewhat concerned by Renishaw's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 240% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
On a final note, we've found 2 warning signs for Renishaw that we think 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.