Be Wary Of Treatt (LON:TET) And Its Returns On Capital
If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Treatt (LON:TET) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding 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 Treatt, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = UK£16m ÷ (UK£188m - UK£46m) (Based on the trailing twelve months to September 2022).
Thus, Treatt has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Chemicals industry average of 13%.
Check out our latest analysis for Treatt
Above you can see how the current ROCE for Treatt 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 Treatt.
So How Is Treatt's ROCE Trending?
In terms of Treatt's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 20%, but since then they've fallen to 11%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Bottom Line
While returns have fallen for Treatt in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 49% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
One more thing, we've spotted 1 warning sign facing Treatt that you might find interesting.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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