- Oops!Something went wrong.Please try again later.
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Speaking of which, we noticed some great changes in Hornby's (LON:HRN) returns on capital, so let's have a look.
What is 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 Hornby is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.019 = UK£767k ÷ (UK£49m - UK£8.0m) (Based on the trailing twelve months to March 2021).
Therefore, Hornby has an ROCE of 1.9%. Ultimately, that's a low return and it under-performs the Leisure industry average of 22%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Hornby's ROCE against it's prior returns. If you're interested in investigating Hornby's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
We're delighted to see that Hornby is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 1.9% on its capital. Not only that, but the company is utilizing 26% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
One more thing to note, Hornby has decreased current liabilities to 16% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
The Bottom Line On Hornby's ROCE
Overall, Hornby gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And with a respectable 47% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. Therefore, we think it would be worth your time to check if these trends are going to continue.
One more thing to note, we've identified 2 warning signs with Hornby and understanding them should be part of your investment process.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.