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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Performance Shipping's (NASDAQ:PSHG) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
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. The formula for this calculation on Performance Shipping is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.061 = US$9.0m ÷ (US$156m - US$8.1m) (Based on the trailing twelve months to June 2020).
So, Performance Shipping has an ROCE of 6.1%. In absolute terms, that's a low return but it's around the Shipping industry average of 7.0%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Performance Shipping's ROCE against it's prior returns. If you're interested in investigating Performance Shipping's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
You'd find it hard not to be impressed with the ROCE trend at Performance Shipping. We found that the returns on capital employed over the last five years have risen by 166%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 63% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.
From what we've seen above, Performance Shipping has managed to increase it's returns on capital all the while reducing it's capital base. Although the company may be facing some issues elsewhere since the stock has plunged 100% in the last five years. In any case, we believe the economic trends of this company are positive and looking into the stock further could prove rewarding.
Like most companies, Performance Shipping does come with some risks, and we've found 3 warning signs that 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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