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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Having said that, from a first glance at Ricardo (LON:RCDO) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding Return On Capital Employed (ROCE)
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. The formula for this calculation on Ricardo is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.061 = UK£18m ÷ (UK£391m - UK£101m) (Based on the trailing twelve months to June 2021).
So, Ricardo has an ROCE of 6.1%. In absolute terms, that's a low return and it also under-performs the Professional Services industry average of 12%.
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'd like to see what analysts are forecasting going forward, you should check out our free report for Ricardo.
What The Trend Of ROCE Can Tell Us
In terms of Ricardo's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.1% from 16% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
In Conclusion...
Bringing it all together, while we're somewhat encouraged by Ricardo's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 49% so the market doesn't look too hopeful on these trends strengthening any time soon. 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.
If you'd like to know about the risks facing Ricardo, we've discovered 4 warning signs that you should be aware of.