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There are a few key trends to look for if we want to identify the next multi-bagger. 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. Although, when we looked at Arrow Electronics (NYSE:ARW), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
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 Arrow Electronics is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$764m ÷ (US$15b - US$7.9b) (Based on the trailing twelve months to September 2020).
Thus, Arrow Electronics has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 11% generated by the Electronic industry.
Above you can see how the current ROCE for Arrow Electronics compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Arrow Electronics.
So How Is Arrow Electronics' ROCE Trending?
There hasn't been much to report for Arrow Electronics' returns and its level of capital employed because both metrics have been steady for the past five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect Arrow Electronics to be a multi-bagger going forward.
Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 51% of total assets, this reported ROCE would probably be less than10% because total capital employed would be higher.The 10% ROCE could be even lower if current liabilities weren't 51% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.
Our Take On Arrow Electronics' ROCE
We can conclude that in regards to Arrow Electronics' returns on capital employed and the trends, there isn't much change to report on. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 117% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
If you want to continue researching Arrow Electronics, you might be interested to know about the 3 warning signs that our analysis has discovered.
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.
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