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There are a few key trends to look for if we want to identify the next multi-bagger. 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. Having said that, from a first glance at KMD Brands (NZSE:KMD) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What Is 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. Analysts use this formula to calculate it for KMD Brands:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.014 = NZ$16m ÷ (NZ$1.4b - NZ$243m) (Based on the trailing twelve months to July 2024).
Therefore, KMD Brands has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 19%.
View our latest analysis for KMD Brands
In the above chart we have measured KMD Brands' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for KMD Brands .
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at KMD Brands, we didn't gain much confidence. Around five years ago the returns on capital were 16%, but since then they've fallen to 1.4%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
The Key Takeaway
In summary, we're somewhat concerned by KMD Brands' diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last five years have experienced a 46% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.