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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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Caesarstone (NASDAQ:CSTE) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. Analysts use this formula to calculate it for Caesarstone:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = US$25m ÷ (US$689m - US$107m) (Based on the trailing twelve months to June 2020).
Therefore, Caesarstone has an ROCE of 4.3%. Ultimately, that's a low return and it under-performs the Building industry average of 13%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Caesarstone's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
In terms of Caesarstone's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 27% over the last five years. 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.
What We Can Learn From Caesarstone's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Caesarstone have fallen, meanwhile the business is employing more capital than it was five years ago. We expect this has contributed to the stock plummeting 72% during the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
If you'd like to know more about Caesarstone, we've spotted 3 warning signs, and 1 of them shouldn't be ignored.
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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