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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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Baxter International (NYSE:BAX) and its trend of ROCE, we really liked what we saw.
Understanding 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 Baxter International:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$1.8b ÷ (US$19b - US$3.2b) (Based on the trailing twelve months to March 2021).
Therefore, Baxter International has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 8.4% generated by the Medical Equipment industry.
Above you can see how the current ROCE for Baxter International compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Baxter International.
What Does the ROCE Trend For Baxter International Tell Us?
We like the trends that we're seeing from Baxter International. The data shows that returns on capital have increased substantially over the last five years to 11%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 20%. So we're very much inspired by what we're seeing at Baxter International thanks to its ability to profitably reinvest capital.
The Key Takeaway
To sum it up, Baxter International has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has returned a staggering 106% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing to note, we've identified 3 warning signs with Baxter International and understanding these should be part of your investment process.
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. 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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