There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Treatt (LON:TET), it didn't seem to tick all of these boxes.
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. The formula for this calculation on Treatt is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = UK£17m ÷ (UK£164m - UK£40m) (Based on the trailing twelve months to March 2022).
Therefore, Treatt has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 11% it's much better.
Above you can see how the current ROCE for Treatt 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 Does the ROCE Trend For Treatt Tell Us?
When we looked at the ROCE trend at Treatt, we didn't gain much confidence. To be more specific, ROCE has fallen from 19% over the last five years. 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.
The Key Takeaway
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Treatt. And the stock has followed suit returning a meaningful 94% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
One final note, you should learn about the 2 warning signs we've spotted with Treatt (including 1 which is concerning) .
While Treatt isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.