Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. That's why when we briefly looked at RATIONAL's (ETR:RAA) ROCE trend, we were very happy with what we saw.
Return On Capital Employed (ROCE): What Is It?
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. Analysts use this formula to calculate it for RATIONAL:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.34 = €257m ÷ (€934m - €173m) (Based on the trailing twelve months to March 2023).
Therefore, RATIONAL has an ROCE of 34%. In absolute terms that's a great return and it's even better than the Machinery industry average of 11%.
See our latest analysis for RATIONAL
Above you can see how the current ROCE for RATIONAL compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering RATIONAL here for free.
How Are Returns Trending?
We'd be pretty happy with returns on capital like RATIONAL. The company has employed 58% more capital in the last five years, and the returns on that capital have remained stable at 34%. Now considering ROCE is an attractive 34%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
The Bottom Line
In short, we'd argue RATIONAL has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And given the stock has only risen 31% over the last five years, we'd suspect the market is beginning to recognize these trends. So because of the trends we're seeing, we'd recommend looking further into this stock to see if it has the makings of a multi-bagger.
On a separate note, we've found 1 warning sign for RATIONAL you'll probably want to know about.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.