There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we’ll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. However, after investigating Zotefoams (LON:ZTF), we don’t think it’s current trends fit the mold of a multi-bagger.
Understanding 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 Zotefoams is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.09 = UK£9.9m ÷ (UK£173m – UK£63m) (Based on the trailing twelve months to June 2022).
Therefore, Zotefoams has an ROCE of 9.0%. In absolute terms, that’s a low return but it’s around the Chemicals industry average of 10%.
See our latest analysis for Zotefoams
In the above chart we have measured Zotefoams’ 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 Zotefoams’ ROCE Trend?
On the surface, the trend of ROCE at Zotefoams doesn’t inspire confidence. Around five years ago the returns on capital were 12%, but since then they’ve fallen to 9.0%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 36%, which has impacted the ROCE. If current liabilities hadn’t increased as much as they did, the ROCE could actually be even lower. While the ratio isn’t currently too high, it’s worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
What We Can Learn From Zotefoams’ ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Zotefoams. However, despite the promising trends, the stock has fallen 19% over the last five years, so there might be an opportunity here for astute investors. As a result, we’d recommend researching this stock further to uncover what other fundamentals of the business can show us.
One more thing to note, we’ve identified 2 warning signs with Zotefoams and understanding these should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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