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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Clover (ASX:CLV), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Clover:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.042 = AU$3.1m ÷ (AU$84m - AU$9.8m) (Based on the trailing twelve months to July 2024).
So, Clover has an ROCE of 4.2%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 8.1%.
Check out our latest analysis for Clover
Above you can see how the current ROCE for Clover compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Clover .
What Can We Tell From Clover's ROCE Trend?
In terms of Clover's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 24%, but since then they've fallen to 4.2%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a side note, Clover has done well to pay down its current liabilities to 12% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Key Takeaway
We're a bit apprehensive about Clover because despite more capital being deployed in the business, returns on that capital and sales have both fallen. We expect this has contributed to the stock plummeting 79% during the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.