If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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, when we ran our eye over Macfarlane Group's (LON:MACF) trend of ROCE, we liked what we saw.
What Is Return On Capital Employed (ROCE)?
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. The formula for this calculation on Macfarlane Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = UK£20m ÷ (UK£223m - UK£86m) (Based on the trailing twelve months to June 2022).
So, Macfarlane Group has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 13% generated by the Trade Distributors industry.
Above you can see how the current ROCE for Macfarlane Group 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 Macfarlane Group here for free.
How Are Returns Trending?
While the returns on capital are good, they haven't moved much. Over the past five years, ROCE has remained relatively flat at around 15% and the business has deployed 147% more capital into its operations. Since 15% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 39% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
What We Can Learn From Macfarlane Group's ROCE
To sum it up, Macfarlane Group has simply been reinvesting capital steadily, at those decent rates of return. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
While Macfarlane Group doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.
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.
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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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