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If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Estia Health (ASX:EHE), we don't think it's current trends fit the mold of a multi-bagger.
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. The formula for this calculation on Estia Health is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.096 = AU$87m ÷ (AU$1.9b - AU$960m) (Based on the trailing twelve months to June 2020).
Thus, Estia Health has an ROCE of 9.6%. On its own that's a low return, but compared to the average of 7.8% generated by the Healthcare industry, it's much better.
In the above chart we have measured Estia Health's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Estia Health here for free.
So How Is Estia Health's ROCE Trending?
There are better returns on capital out there than what we're seeing at Estia Health. The company has consistently earned 9.6% for the last five years, and the capital employed within the business has risen 57% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
On a side note, Estia Health's current liabilities are still rather high at 51% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From Estia Health's ROCE
In conclusion, Estia Health has been investing more capital into the business, but returns on that capital haven't increased. Since the stock has declined 56% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Estia Health has the makings of a multi-bagger.
On a final note, we've found 1 warning sign for Estia Health 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.
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