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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, Environmental Group (ASX:EGL) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What is it?
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 Environmental Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.082 = AU$2.2m ÷ (AU$40m - AU$13m) (Based on the trailing twelve months to December 2021).
Therefore, Environmental Group has an ROCE of 8.2%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.2%.
View our latest analysis for Environmental Group
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 Environmental Group's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. The data shows that returns on capital have increased substantially over the last five years to 8.2%. Basically the business is earning more per dollar of capital invested and in addition to that, 95% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
In Conclusion...
To sum it up, Environmental Group has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And a remarkable 949% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Environmental Group (of which 1 is a bit unpleasant!) that you should know about.