If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, rhipe (ASX:RHP) looks quite promising in regards to its trends of return on capital.
What is Return On Capital Employed (ROCE)?
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 rhipe is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.076 = AU$7.3m ÷ (AU$149m - AU$54m) (Based on the trailing twelve months to June 2020).
Therefore, rhipe has an ROCE of 7.7%. Ultimately, that's a low return and it under-performs the IT industry average of 9.9%.
View our latest analysis for rhipe
In the above chart we have measured rhipe'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 report on analyst forecasts for the company.
What Can We Tell From rhipe's ROCE Trend?
The fact that rhipe is now generating some pre-tax profits from its prior investments is very encouraging. About five years ago the company was generating losses but things have turned around because it's now earning 7.7% on its capital. And unsurprisingly, like most companies trying to break into the black, rhipe is utilizing 144% more capital than it was five years ago. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
Our Take On rhipe's ROCE
Long story short, we're delighted to see that rhipe's reinvestment activities have paid off and the company is now profitable. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 23% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.
One more thing, we've spotted 3 warning signs facing rhipe that you might find interesting.
While rhipe may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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