If you’re looking for a multi-bagger, there are a few things to look out for. Typically, you want to look at an upward trend in return on invested capital (ROCE) and an associated trend of growing invested capital. Simply put, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at higher rates of return. With that in mind, Scott Technology’s (NZSE:SCT) ROCE looks good right now. Now let’s see what the earnings trend can tell us.
What is Return on Invested Capital (ROCE)?
For those unfamiliar, ROCE is a metric that assesses how much pre-tax profit (as a percentage) a company earns on the capital invested in its business. Analysts calculate ROCE for Scott Technology using the following formula:
Return on Invested Capital = Earnings Before Interest and Taxes (EBIT) ÷ (Total Assets – Current Liabilities)
0.15 = NZ$21m ÷ (NZ$256m – NZ$118m) (Based on the trailing twelve months to February 2024).
So Scott Technology has an ROCE of 15%. In absolute terms, this is a fairly normal return and somewhat close to the Machinery industry average of 14%.
Check out our latest analysis for Scott Technology
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Above we can see how Scott Technology’s current ROCE compares to its prior returns on capital, but the history can only tell us so much, and if you’re interested you can see analyst forecasts in this free analyst report on Scott Technology.
ROCE Trends
While the ROCE trend is less impressive, overall returns are decent. The company has deployed over 22% of its capital over the past five years, and its return on capital has remained stable at 15%. However, 15% is a moderate ROCE, so it’s good to see the company can continue to reinvest at such a decent rate of return. Over the long term, returns like this may not be all that attractive, but consistency can pay off in terms of price-to-earnings ratios.
Another thing to note is that the company has increased its current liabilities over the past five years. This is interesting. If current liabilities had not increased to 46% of total assets, this reported ROCE would likely be less than 15% because total capitalization would be higher. If current liabilities were not 46% of total assets, the 15% ROCE would likely be even lower because the formula would show a larger base of total capitalization. So, having such a high level of current liabilities essentially means that suppliers and short-term creditors are funding a significant portion of the business, which could pose a risk in some cases.
The story continues
Conclusion
After all, Scott Technology has proven its ability to reinvest capital appropriately and achieve strong rates of return, and given that the share price has risen just 16% over the last five years, it seems likely the market is beginning to recognize this trend. This is why it may be worth taking a closer look at this stock to see if it has more of the attributes of a multi-bagger.
Finally, you should be aware of the 3 warning signs we’ve spotted with Scott Technology (including 1 which is a bit concerning)
While Scott Technology doesn’t have the highest profit margins, check out this free list of companies with rock-solid balance sheets and high returns on equity.
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This article by Simply Wall St is of general nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology, and our articles are not intended as financial advice. It is not a recommendation to buy or sell a stock, and does not take into account your objectives or financial situation. We aim to provide long-term analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned herein.
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