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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Having said that, from a first glance at Taylor Devices (NASDAQ:TAYD) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper 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 Taylor Devices is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.084 = US$3.3m ÷ (US$45m - US$5.5m) (Based on the trailing twelve months to May 2020).
Therefore, Taylor Devices has an ROCE of 8.4%. On its own, that's a low figure but it's around the 9.1% average generated by the Machinery industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Taylor Devices' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Taylor Devices, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Taylor Devices, we didn't gain much confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 8.4%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a related note, Taylor Devices has decreased its current liabilities to 12% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
Our Take On Taylor Devices' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Taylor Devices have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 31% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
If you want to know some of the risks facing Taylor Devices we've found 2 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.
While Taylor Devices 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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