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To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Lavoro (NASDAQ:LVRO) so let's look a bit deeper.
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 Lavoro:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = R$342m ÷ (R$5.7b - R$3.8b) (Based on the trailing twelve months to June 2022).
Thus, Lavoro has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Trade Distributors industry average of 14% it's much better.
See our latest analysis for Lavoro
In the above chart we have measured Lavoro's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Lavoro's ROCE Trend?
Lavoro is displaying some positive trends. The numbers show that in the last one year, the returns generated on capital employed have grown considerably to 18%. The amount of capital employed has increased too, by 21%. So we're very much inspired by what we're seeing at Lavoro thanks to its ability to profitably reinvest capital.
On a side note, Lavoro's current liabilities are still rather high at 67% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From Lavoro's ROCE
All in all, it's terrific to see that Lavoro is reaping the rewards from prior investments and is growing its capital base. Given the stock has declined 40% in the last year, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.