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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. However, after briefly looking over the numbers, we don't think VEEM (ASX:VEE) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. The formula for this calculation on VEEM is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.031 = AU$2.1m ÷ (AU$81m - AU$13m) (Based on the trailing twelve months to June 2022).
So, VEEM has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Machinery industry average of 12%.
Check out our latest analysis for VEEM
In the above chart we have measured VEEM's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for VEEM.
What Does the ROCE Trend For VEEM Tell Us?
The trend of ROCE doesn't look fantastic because it's fallen from 19% five years ago, while the business's capital employed increased by 108%. That being said, VEEM raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence VEEM might not have received a full period of earnings contribution from it.
On a related note, VEEM has decreased its current liabilities to 16% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
What We Can Learn From VEEM's ROCE
To conclude, we've found that VEEM is reinvesting in the business, but returns have been falling. And with the stock having returned a mere 23% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
One more thing, we've spotted 2 warning signs facing VEEM that you might find interesting.
While VEEM may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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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