Did you know there are some financial metrics that can provide clues of a potential multi-bagger? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Top Ships' (NASDAQ:TOPS) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Top Ships:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.057 = US$15m ÷ (US$293m - US$25m) (Based on the trailing twelve months to December 2020).
Therefore, Top Ships has an ROCE of 5.7%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 8.0%.
In the above chart we have measured Top Ships' 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.
So How Is Top Ships' ROCE Trending?
We're delighted to see that Top Ships is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 5.7% on its capital. Not only that, but the company is utilizing 367% more capital than before, but that's to be expected from a company trying to break into profitability. 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.
On a related note, the company's ratio of current liabilities to total assets has decreased to 8.7%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.
What We Can Learn From Top Ships' ROCE
Overall, Top Ships gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. However the stock is down a substantial 100% in the last five years so there could be other areas of the business hurting its prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.
Top Ships does have some risks, we noticed 5 warning signs (and 2 which don't sit too well with us) we think you should know about.
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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