If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. So when we looked at Pro-Dex (NASDAQ:PDEX) and its trend of ROCE, we really liked what we saw.
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. To calculate this metric for Pro-Dex, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$6.1m ÷ (US$42m - US$6.5m) (Based on the trailing twelve months to March 2021).
Thus, Pro-Dex has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Medical Equipment industry average of 8.4% it's much better.
In the above chart we have measured Pro-Dex's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Pro-Dex's ROCE Trend?
We like the trends that we're seeing from Pro-Dex. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 17%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 284%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
What We Can Learn From Pro-Dex's ROCE
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Pro-Dex has. Since the stock has returned a staggering 742% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Pro-Dex (of which 2 are concerning!) that you should know about.
While Pro-Dex may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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