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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Construction Partners (NASDAQ:ROAD) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
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. To calculate this metric for Construction Partners, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$54m ÷ (US$616m - US$126m) (Based on the trailing twelve months to March 2021).
Therefore, Construction Partners has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 9.8% generated by the Construction industry.
In the above chart we have measured Construction Partners' 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 Does the ROCE Trend For Construction Partners Tell Us?
We weren't thrilled with the trend because Construction Partners' ROCE has reduced by 38% over the last four years, while the business employed 126% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Construction Partners might not have received a full period of earnings contribution from it. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.
On a side note, Construction Partners has done well to pay down its current liabilities to 21% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Key Takeaway
To conclude, we've found that Construction Partners is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 149% gain to shareholders who have held over the last three years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
If you're still interested in Construction Partners it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.
While Construction Partners 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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