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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'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don't think Varex Imaging (NASDAQ:VREX) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
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 Varex Imaging, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.034 = US$33m ÷ (US$1.2b - US$186m) (Based on the trailing twelve months to July 2021).
Thus, Varex Imaging has an ROCE of 3.4%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 8.9%.
Above you can see how the current ROCE for Varex Imaging compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Varex Imaging here for free.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Varex Imaging doesn't inspire confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 3.4%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Varex Imaging's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly then, the total return to shareholders over the last three years has been flat. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
On a final note, we've found 1 warning sign for Varex Imaging that we think you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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