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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. So on that note, XP Factory (LON:XPF) looks quite promising in regards to its trends of return on capital.
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. Analysts use this formula to calculate it for XP Factory:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.031 = UK£1.8m ÷ (UK£73m - UK£17m) (Based on the trailing twelve months to March 2024).
Therefore, XP Factory has an ROCE of 3.1%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 8.3%.
View our latest analysis for XP Factory
In the above chart we have measured XP Factory's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering XP Factory for free.
What Can We Tell From XP Factory's ROCE Trend?
XP Factory has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 3.1% on its capital. Not only that, but the company is utilizing 306% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 23% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
In Conclusion...
Overall, XP Factory gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. With that in mind, we believe the promising trends warrant this stock for further investigation.