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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Ergo, when we looked at the ROCE trends at Standard Motor Products (NYSE:SMP), we liked what we saw.
What is Return On Capital Employed (ROCE)?
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. The formula for this calculation on Standard Motor Products is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = US$147m ÷ (US$1.2b - US$447m) (Based on the trailing twelve months to June 2021).
Therefore, Standard Motor Products has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.
In the above chart we have measured Standard Motor Products' 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 Standard Motor Products here for free.
What The Trend Of ROCE Can Tell Us
It's hard not to be impressed by Standard Motor Products' returns on capital. Over the past five years, ROCE has remained relatively flat at around 21% and the business has deployed 52% more capital into its operations. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
The Bottom Line On Standard Motor Products' ROCE
Standard Motor Products has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. And given the stock has only risen 2.8% over the last five years, we'd suspect the market is beginning to recognize these trends. That's why it could be worth your time looking into this stock further to discover if it has more traits of a multi-bagger.
Standard Motor Products does have some risks, we noticed 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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