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If you're looking for a multi-bagger, there's a few things to 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Vector (NZSE:VCT), it didn't seem to tick all of these boxes.
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. To calculate this metric for Vector, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.06 = NZ$311m ÷ (NZ$6.2b - NZ$951m) (Based on the trailing twelve months to December 2019).
So, Vector has an ROCE of 6.0%. On its own, that's a low figure but it's around the 5.5% average generated by the Integrated Utilities industry.
Above you can see how the current ROCE for Vector compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Vector.
How Are Returns Trending?
Over the past five years, Vector's ROCE and capital employed have both remained mostly flat. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So don't be surprised if Vector doesn't end up being a multi-bagger in a few years time. On top of that you'll notice that Vector has been paying out a large portion (133%) of earnings in the form of dividends to shareholders. Most shareholders probably know this and own the stock for its dividend.
The Bottom Line On Vector's ROCE
In summary, Vector isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Although the market must be expecting these trends to improve because the stock has gained 48% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One final note, you should learn about the 4 warning signs we've spotted with Vector (including 2 which is are a bit unpleasant) .
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. 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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