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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So on that note, Rolls-Royce Holdings (LON:RR.) looks quite promising in regards to its trends of return on capital.
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. Analysts use this formula to calculate it for Rolls-Royce Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = UK£2.3b ÷ (UK£33b - UK£15b) (Based on the trailing twelve months to June 2024).
Therefore, Rolls-Royce Holdings has an ROCE of 13%. That's a relatively normal return on capital, and it's around the 14% generated by the Aerospace & Defense industry.
Check out our latest analysis for Rolls-Royce Holdings
Above you can see how the current ROCE for Rolls-Royce Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Rolls-Royce Holdings .
So How Is Rolls-Royce Holdings' ROCE Trending?
Rolls-Royce Holdings has broken into the black (profitability) and we're sure it's a sight for sore eyes. The company now earns 13% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. Because in the end, a business can only get so efficient.
On a side note, Rolls-Royce Holdings' current liabilities are still rather high at 46% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From Rolls-Royce Holdings' ROCE
As discussed above, Rolls-Royce Holdings appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a staggering 157% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Rolls-Royce Holdings can keep these trends up, it could have a bright future ahead.