To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Richardson Electronics (NASDAQ:RELL) so let's look a bit deeper.
Return On Capital Employed (ROCE): What is it?
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. To calculate this metric for Richardson Electronics, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.09 = US$12m ÷ (US$165m - US$36m) (Based on the trailing twelve months to November 2021).
Therefore, Richardson Electronics has an ROCE of 9.0%. On its own, that's a low figure but it's around the 9.8% average generated by the Electronic industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Richardson Electronics has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Richardson Electronics Tell Us?
Richardson Electronics has broken into the black (profitability) and we're sure it's a sight for sore eyes. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 9.0%, which is always encouraging. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
The Bottom Line On Richardson Electronics' ROCE
To sum it up, Richardson Electronics is collecting higher returns from the same amount of capital, and that's impressive. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Richardson Electronics can keep these trends up, it could have a bright future ahead.
One more thing to note, we've identified 1 warning sign with Richardson Electronics and understanding this should be part of your investment process.
While Richardson Electronics 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.