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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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 while Nichols (LON:NICL) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Return On Capital Employed (ROCE): What Is It?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Nichols is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.26 = UK£27m ÷ (UK£136m - UK£33m) (Based on the trailing twelve months to June 2024).
Therefore, Nichols has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Beverage industry average of 15%.
View our latest analysis for Nichols
Above you can see how the current ROCE for Nichols 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 Nichols for free.
What Can We Tell From Nichols' ROCE Trend?
Over the past five years, Nichols' ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. Although current returns are high, we'd need more evidence of underlying growth for it to look like a multi-bagger going forward. This probably explains why Nichols is paying out 50% of its income to shareholders in the form of dividends. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.
Our Take On Nichols' ROCE
Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. And investors appear hesitant that the trends will pick up because the stock has fallen 25% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.