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To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, Frontier Developments (LON:FDEV) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What is it?
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 Frontier Developments is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = UK£17m ÷ (UK£148m - UK£16m) (Based on the trailing twelve months to May 2020).
So, Frontier Developments has an ROCE of 13%. That's a pretty standard return and it's in line with the industry average of 13%.
Above you can see how the current ROCE for Frontier Developments 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 Frontier Developments.
How Are Returns Trending?
Investors would be pleased with what's happening at Frontier Developments. The data shows that returns on capital have increased substantially over the last five years to 13%. Basically the business is earning more per dollar of capital invested and in addition to that, 502% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
The Key Takeaway
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Frontier Developments has. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. 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.
One more thing, we've spotted 2 warning signs facing Frontier Developments that you might find interesting.
While Frontier Developments may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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