To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it’s a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Richardson Electronics (NASDAQ:RELL) and its trend of ROCE, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
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)
0.036 = US$4.5m ÷ (US$157m – US$32m) (Based on the trailing twelve months to May 2021).
Thus, Richardson Electronics has an ROCE of 3.6%. In absolute terms, that’s a low return and it also under-performs the Electronic industry average of 10%.
Check out our latest analysis for Richardson Electronics
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 want to delve into the historical earnings, revenue and cash flow of Richardson Electronics, check out these free graphs here.
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. While the business was unprofitable in the past, it’s now turned things around and is earning 3.6% on its capital. 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. That being said, while an increase in efficiency is no doubt appealing, it’d be helpful to know if the company does have any investment plans going forward. So if you’re looking for high growth, you’ll want to see a business’s capital employed also increasing.
To bring it all together, Richardson Electronics has done well to increase the returns it’s generating from its capital employed. Since the stock has returned a solid 78% to shareholders over the last five years, it’s fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it’s worth researching the company further to see if these trends are likely to persist.
If you want to continue researching Richardson Electronics, you might be interested to know about the 3 warning signs that our analysis has discovered.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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.
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