To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Eltek (NASDAQ:ELTK) so let's look a bit deeper.
What Is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Eltek is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.057 = US$1.8m ÷ (US$40m - US$9.4m) (Based on the trailing twelve months to June 2022).
So, Eltek has an ROCE of 5.7%. Ultimately, that's a low return and it under-performs the Electronic industry average of 12%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Eltek's ROCE against it's prior returns. If you'd like to look at how Eltek has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Eltek Tell Us?
The fact that Eltek is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 5.7% which is a sight for sore eyes. In addition to that, Eltek is employing 330% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
On a related note, the company's ratio of current liabilities to total assets has decreased to 23%, 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.
The Key Takeaway
To the delight of most shareholders, Eltek has now broken into profitability. Since the stock has only returned 24% 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.
Eltek does have some risks, we noticed 2 warning signs (and 1 which is potentially serious) we think you should know about.
While Eltek isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
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