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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? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 NFON (ETR:NFN) so let's look a bit deeper.
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. The formula for this calculation on NFON is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.02 = €1.2m ÷ (€74m - €16m) (Based on the trailing twelve months to June 2024).
Thus, NFON has an ROCE of 2.0%. Ultimately, that's a low return and it under-performs the Telecom industry average of 5.9%.
View our latest analysis for NFON
In the above chart we have measured NFON's 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 NFON .
What Does the ROCE Trend For NFON Tell Us?
The fact that NFON is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 2.0% which is a sight for sore eyes. Not only that, but the company is utilizing 29% 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.
The Bottom Line
In summary, it's great to see that NFON has managed to break into profitability and is continuing to reinvest in its business. Astute investors may have an opportunity here because the stock has declined 44% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.
One more thing to note, we've identified 2 warning signs with NFON and understanding these should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.