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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Speaking of which, we noticed some great changes in Black Diamond Group's (TSE:BDI) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for Black Diamond Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.04 = CA$19m ÷ (CA$549m - CA$86m) (Based on the trailing twelve months to September 2021).
Therefore, Black Diamond Group has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 7.8%.
Above you can see how the current ROCE for Black Diamond Group 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 Black Diamond Group here for free.
The Trend Of ROCE
We're delighted to see that Black Diamond Group is reaping rewards from its investments and has now broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 4.0%, which is always encouraging. While returns have increased, the amount of capital employed by Black Diamond Group has remained flat over the period. 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. Because in the end, a business can only get so efficient.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 16% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
To sum it up, Black Diamond Group is collecting higher returns from the same amount of capital, and that's impressive. Since the stock has only returned 9.1% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.
Like most companies, Black Diamond Group does come with some risks, and we've found 2 warning signs that you should be aware of.
While Black Diamond Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.