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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Ricardo (LON:RCDO) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. The formula for this calculation on Ricardo is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.033 = UK£10m ÷ (UK£429m - UK£116m) (Based on the trailing twelve months to December 2023).
Therefore, Ricardo has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Professional Services industry average of 18%.
See our latest analysis for Ricardo
In the above chart we have measured Ricardo's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Ricardo .
The Trend Of ROCE
When we looked at the ROCE trend at Ricardo, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
In Conclusion...
In summary, despite lower returns in the short term, we're encouraged to see that Ricardo is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 23% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
If you'd like to know about the risks facing Ricardo, we've discovered 1 warning sign that you should be aware of.
While Ricardo isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.