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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Having said that, from a first glance at RGC Resources (NASDAQ:RGCO) 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)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for RGC Resources:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = US$13m ÷ (US$292m - US$21m) (Based on the trailing twelve months to March 2021).
So, RGC Resources has an ROCE of 5.0%. In absolute terms, that's a low return but it's around the Gas Utilities industry average of 5.8%.
Above you can see how the current ROCE for RGC Resources 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 RGC Resources.
So How Is RGC Resources' ROCE Trending?
When we looked at the ROCE trend at RGC Resources, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.0% from 8.1% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
What We Can Learn From RGC Resources' ROCE
In summary, RGC Resources is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 73% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
RGC Resources does have some risks though, and we've spotted 1 warning sign for RGC Resources that you might be interested in.
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. 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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