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If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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 Energy Recovery (NASDAQ:ERII) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What Is 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 Energy Recovery is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.06 = US$15m ÷ (US$263m - US$19m) (Based on the trailing twelve months to September 2024).
Therefore, Energy Recovery has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Machinery industry average of 13%.
Check out our latest analysis for Energy Recovery
Above you can see how the current ROCE for Energy Recovery 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 Energy Recovery for free.
What The Trend Of ROCE Can Tell Us
In terms of Energy Recovery's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.0% from 7.8% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Key Takeaway
While returns have fallen for Energy Recovery in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 85% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.
If you want to continue researching Energy Recovery, you might be interested to know about the 2 warning signs that our analysis has discovered.