There are a few key trends to look for if we want to identify the next multi-bagger. 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. Although, when we looked at LS 2 Holdings (Catalist:ENV), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
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. To calculate this metric for LS 2 Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.063 = S$1.3m ÷ (S$31m - S$11m) (Based on the trailing twelve months to June 2023).
Thus, LS 2 Holdings has an ROCE of 6.3%. On its own, that's a low figure but it's around the 6.6% average generated by the Commercial Services industry.
Check out our latest analysis for LS 2 Holdings
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of LS 2 Holdings, check out these free graphs here.
The Trend Of ROCE
When we looked at the ROCE trend at LS 2 Holdings, we didn't gain much confidence. Over the last four years, returns on capital have decreased to 6.3% from 14% four years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a related note, LS 2 Holdings has decreased its current liabilities to 35% of total assets. That could partly explain why the ROCE has dropped. 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.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by LS 2 Holdings' reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 56% in the last year. Therefore based on the analysis done in this article, we don't think LS 2 Holdings has the makings of a multi-bagger.