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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. So, when we ran our eye over Hardwoods Distribution's (TSE:HDI) trend of ROCE, we really liked what we saw.
What is 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. The formula for this calculation on Hardwoods Distribution is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = US$80m ÷ (US$550m - US$210m) (Based on the trailing twelve months to June 2021).
So, Hardwoods Distribution has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 19% earned by companies in a similar industry.
In the above chart we have measured Hardwoods Distribution'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 Hardwoods Distribution.
What Does the ROCE Trend For Hardwoods Distribution Tell Us?
It's hard not to be impressed by Hardwoods Distribution's returns on capital. Over the past five years, ROCE has remained relatively flat at around 23% and the business has deployed 203% more capital into its operations. Now considering ROCE is an attractive 23%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
Our Take On Hardwoods Distribution's ROCE
Hardwoods Distribution has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. And the stock has done incredibly well with a 130% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Hardwoods Distribution (of which 2 are a bit concerning!) that you should know about.
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. 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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