If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Volcano Berhad (KLSE:VOLCANO) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Volcano Berhad is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.089 = RM7.3m ÷ (RM94m - RM11m) (Based on the trailing twelve months to June 2022).
Therefore, Volcano Berhad has an ROCE of 8.9%. Ultimately, that's a low return and it under-performs the Machinery industry average of 12%.
View our latest analysis for Volcano Berhad
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're interested in investigating Volcano Berhad's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
When we looked at the ROCE trend at Volcano Berhad, we didn't gain much confidence. Over the last three years, returns on capital have decreased to 8.9% from 11% three years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Volcano Berhad is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 13% over the last year, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
One more thing, we've spotted 2 warning signs facing Volcano Berhad that you might find interesting.
While Volcano Berhad 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.