If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at Chemed's (NYSE:CHE) ROCE trend, we were very happy with what we saw.
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. To calculate this metric for Chemed, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.30 = US$336m ÷ (US$1.4b - US$267m) (Based on the trailing twelve months to June 2021).
Therefore, Chemed has an ROCE of 30%. In absolute terms that's a great return and it's even better than the Healthcare industry average of 12%.
In the above chart we have measured Chemed's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Chemed.
How Are Returns Trending?
Chemed deserves to be commended in regards to it's returns. The company has employed 63% more capital in the last five years, and the returns on that capital have remained stable at 30%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.
The Bottom Line On Chemed's ROCE
In summary, we're delighted to see that Chemed has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And the stock has done incredibly well with a 252% return over the last five years, so long term investors are no doubt ecstatic with that result. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
Like most companies, Chemed does come with some risks, and we've found 1 warning sign that you should be aware of.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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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