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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Middleby (NASDAQ:MIDD) 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)
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 Middleby, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.089 = US$406m ÷ (US$5.3b - US$714m) (Based on the trailing twelve months to April 2021).
So, Middleby has an ROCE of 8.9%. In absolute terms, that's a low return but it's around the Machinery industry average of 9.6%.
In the above chart we have measured Middleby's 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.
How Are Returns Trending?
When we looked at the ROCE trend at Middleby, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% 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.
The Bottom Line On Middleby's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Middleby have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 46% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Middleby does have some risks though, and we've spotted 1 warning sign for Middleby that you might be interested in.
While Middleby 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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