If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 on that note, Pental (ASX:PTL) looks quite promising in regards to its trends of return on capital.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Pental is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.16 = AU$9.4m ÷ (AU$81m - AU$22m) (Based on the trailing twelve months to December 2020).

Therefore, Pental has an ROCE of 16%. That's a pretty standard return and it's in line with the industry average of 16%.

See our latest analysis for Pental

In the above chart we have measured Pental'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.

So How Is Pental's ROCE Trending?

You'd find it hard not to be impressed with the ROCE trend at Pental. We found that the returns on capital employed over the last five years have risen by 56%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Speaking of capital employed, the company is actually utilizing 28% less than it was five years ago, which can be indicative of a business that's improving its efficiency. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 27% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

What We Can Learn From Pental's ROCE

In summary, it's great to see that Pental has been able to turn things around and earn higher returns on lower amounts of capital. Astute investors may have an opportunity here because the stock has declined 21% in the last five years. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

On a separate note, we've found 2 warning signs for Pental you'll probably want to know about.

While Pental 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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