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If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Looking at Sturm Ruger (NYSE:RGR), it does have a high ROCE right now, but lets see how returns are trending.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Sturm Ruger is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.36 = US$87m ÷ (US$311m - US$67m) (Based on the trailing twelve months to September 2020).
Therefore, Sturm Ruger has an ROCE of 36%. In absolute terms that's a great return and it's even better than the Leisure industry average of 20%.
Above you can see how the current ROCE for Sturm Ruger 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 Sturm Ruger here for free.
What The Trend Of ROCE Can Tell Us
Over the past five years, Sturm Ruger's ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. Although current returns are high, we'd need more evidence of underlying growth for it to look like a multi-bagger going forward.
What We Can Learn From Sturm Ruger's ROCE
While Sturm Ruger has impressive profitability from its capital, it isn't increasing that amount of capital. And with the stock having returned a mere 24% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
If you want to know some of the risks facing Sturm Ruger we've found 3 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
High returns are a key ingredient to strong performance, so check out our free list ofstocks 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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