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. And in light of that, the trends we’re seeing at SPAR Group’s (NASDAQ:SGRP) look very promising so lets take a look.
What is Return On Capital Employed (ROCE)?
Just to clarify if you’re unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for SPAR Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.23 = US$7.7m ÷ (US$74m – US$41m) (Based on the trailing twelve months to June 2020).
Therefore, SPAR Group has an ROCE of 23%. That’s a fantastic return and not only that, it outpaces the average of 9.6% earned by companies in a similar 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 SPAR Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
SPAR Group’s ROCE growth is quite impressive. 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 104% 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.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 56% of the business, which is more than it was five years ago. And with current liabilities at those levels, that’s pretty high.
The Bottom Line
To bring it all together, SPAR Group has done well to increase the returns it’s generating from its capital employed. Astute investors may have an opportunity here because the stock has declined 45% in the last five years. That being the case, research into the company’s current valuation metrics and future prospects seems fitting.
If you want to know some of the risks facing SPAR Group we’ve found 6 warning signs (1 is potentially serious!) that you should be aware of before investing here.
If you’d like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.