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There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Charles & Colvard's (NASDAQ:CTHR) returns on capital, so let's have a look.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Charles & Colvard is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.073 = US$3.8m ÷ (US$57m - US$6.1m) (Based on the trailing twelve months to March 2021).
Therefore, Charles & Colvard has an ROCE of 7.3%. Ultimately, that's a low return and it under-performs the Luxury industry average of 10%.
In the above chart we have measured Charles & Colvard'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 Charles & Colvard here for free.
What The Trend Of ROCE Can Tell Us
The fact that Charles & Colvard is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 7.3% on its capital. And unsurprisingly, like most companies trying to break into the black, Charles & Colvard is utilizing 33% more capital than it was five years ago. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
Our Take On Charles & Colvard's ROCE
To the delight of most shareholders, Charles & Colvard has now broken into profitability. And a remarkable 186% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
On a final note, we've found 3 warning signs for Charles & Colvard that we think you should be aware of.
While Charles & Colvard isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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