Eastern (NASDAQ: EML) failed to accelerate its returns
If we are to find multi-bagger potential, there are often underlying trends that can provide clues. First, we would like to identify a growth return on capital employed (ROCE) and at the same time, a based capital employed. Put simply, these types of businesses are dialing machines, which means they continually reinvest their profits at ever higher rates of return. Although, when we considered Is (NASDAQ: EML) it didn’t seem to tick all of those boxes.
Understanding Return on Capital Employed (ROCE)
If you’ve never worked with ROCE before, it measures the “return” (profit before tax) that a business generates on capital employed in its business. The formula for this calculation on the East is:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.079 = US $ 19 million ÷ (US $ 281 million – US $ 43 million) (Based on the last twelve months up to April 2021).
So, Eastern has a ROCE of 7.9%. In absolute terms, that’s a low return, but it sits around the machinery industry average of 9.4%.
Check out our latest analysis for the East
Historical performance is a great place to start when researching a stock, so above you can see the gauge of Eastern’s ROCE compared to past returns. If you want to delve into the history of Eastern earnings, income and cash flow, check out these free graphics here.
The ROCE trend
Returns on capital have not changed much for Eastern in recent years. The company has steadily gained 7.9% over the past five years and the capital employed within the company has increased by 123% during this period. Since the company has increased the amount of capital used, it seems that the investments that have been made are simply not providing a high return on capital.
The bottom line
In conclusion, Eastern invested more capital in the business, but the returns on that capital did not increase. Yet to long-term shareholders, the stock has offered them an incredible 119% return over the past five years, so the market seems bullish on its future. But if the trajectory of those underlying trends continues, we think the likelihood of it being a multi-bagging from here is not high.
One more thing to note, we have identified 3 warning signs with Eastern and understanding them should be part of your investment process.
If you want to look for solid businesses with great income, check out this free list of companies with good balance sheets and impressive returns on equity.
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