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There are a few key trends to look for if we want to identify the next multi-bagger. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Vulcan Steel (ASX:VSL) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What Is Return On Capital Employed (ROCE)?
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 Vulcan Steel is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = NZ$99m ÷ (NZ$906m - NZ$169m) (Based on the trailing twelve months to June 2024).
Thus, Vulcan Steel has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 10.0% generated by the Metals and Mining industry.
See our latest analysis for Vulcan Steel
In the above chart we have measured Vulcan Steel's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Vulcan Steel for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Vulcan Steel, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 13% from 23% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Vulcan Steel has done well to pay down its current liabilities to 19% 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.
Our Take On Vulcan Steel's ROCE
We're a bit apprehensive about Vulcan Steel because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Long term shareholders who've owned the stock over the last three years have experienced a 15% 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.