Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Utah Medical Products (NASDAQ:UTMD) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for Utah Medical Products:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$15m ÷ (US$104m - US$3.2m) (Based on the trailing twelve months to June 2020).
Thus, Utah Medical Products has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Medical Equipment industry average of 9.0% it's much better.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Utah Medical Products has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
On the surface, the trend of ROCE at Utah Medical Products doesn't inspire confidence. To be more specific, ROCE has fallen from 22% over the last five years. However it looks like Utah Medical Products might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
What We Can Learn From Utah Medical Products' ROCE
To conclude, we've found that Utah Medical Products is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 60% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Utah Medical Products could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
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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