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There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Victrex (LON:VCT) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Victrex, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = UK£71m ÷ (UK£559m - UK£40m) (Based on the trailing twelve months to March 2021).
Thus, Victrex has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 10% generated by the Chemicals industry.
Above you can see how the current ROCE for Victrex compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Victrex here for free.
What Does the ROCE Trend For Victrex Tell Us?
When we looked at the ROCE trend at Victrex, we didn't gain much confidence. To be more specific, ROCE has fallen from 26% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
What We Can Learn From Victrex's ROCE
In summary, we're somewhat concerned by Victrex's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 101% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Like most companies, Victrex does come with some risks, and we've found 1 warning sign that you should be aware of.
While Victrex isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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