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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, Eleco (LON:ELCO) looks quite promising in regards to its trends of return on capital.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Eleco, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = UK£4.3m ÷ (UK£41m - UK£13m) (Based on the trailing twelve months to December 2020).
Thus, Eleco has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 9.0% it's much better.
Above you can see how the current ROCE for Eleco compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Eleco's ROCE Trend?
We like the trends that we're seeing from Eleco. The data shows that returns on capital have increased substantially over the last five years to 16%. Basically the business is earning more per dollar of capital invested and in addition to that, 192% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
One more thing to note, Eleco has decreased current liabilities to 32% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. This tells us that Eleco has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
Our Take On Eleco's ROCE
All in all, it's terrific to see that Eleco is reaping the rewards from prior investments and is growing its capital base. And a remarkable 471% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.
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. 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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