If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after briefly looking over the numbers, we don't think Héroux-Devtek (TSE:HRX) 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)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Héroux-Devtek is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.073 = CA$48m ÷ (CA$833m - CA$175m) (Based on the trailing twelve months to June 2021).
Thus, Héroux-Devtek has an ROCE of 7.3%. In absolute terms, that's a low return but it's around the Aerospace & Defense industry average of 8.7%.
Above you can see how the current ROCE for Héroux-Devtek compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Héroux-Devtek here for free.
How Are Returns Trending?
There are better returns on capital out there than what we're seeing at Héroux-Devtek. Over the past five years, ROCE has remained relatively flat at around 7.3% and the business has deployed 36% more capital into its operations. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
What We Can Learn From Héroux-Devtek's ROCE
As we've seen above, Héroux-Devtek's returns on capital haven't increased but it is reinvesting in the business. Unsurprisingly, the stock has only gained 32% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
One more thing to note, we've identified 2 warning signs with Héroux-Devtek and understanding these should be part of your investment process.
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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