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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. This shows us that it’s a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Royal Mail (LON:RMG) and its trend of ROCE, we really liked what we saw.
What is 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. To calculate this metric for Royal Mail, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.13 = UK£1.0b ÷ (UK£10b – UK£2.5b) (Based on the trailing twelve months to September 2021).
Therefore, Royal Mail has an ROCE of 13%. That’s a relatively normal return on capital, and it’s around the 14% generated by the Logistics industry.
Check out our latest analysis for Royal Mail
Above you can see how the current ROCE for Royal Mail 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 report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
Royal Mail is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 45% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company’s efficiencies. On that front, things are looking good so it’s worth exploring what management has said about growth plans going forward.
The Bottom Line
As discussed above, Royal Mail appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 2.7% to shareholders. Given that, we’d look further into this stock in case it has more traits that could make it multiply in the long term.
Royal Mail does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is concerning…
While Royal Mail 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.
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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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