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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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Water Intelligence (LON:WATR) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Water Intelligence, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.091 = US$7.2m ÷ (US$97m - US$18m) (Based on the trailing twelve months to December 2023).
Thus, Water Intelligence has an ROCE of 9.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.9%.
Check out our latest analysis for Water Intelligence
Above you can see how the current ROCE for Water Intelligence compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Water Intelligence .
What Can We Tell From Water Intelligence's ROCE Trend?
On the surface, the trend of ROCE at Water Intelligence doesn't inspire confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 9.1%. 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.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by Water Intelligence's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 29% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.