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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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at RediShred Capital (CVE:KUT), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for RediShred Capital, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.032 = CA$1.6m ÷ (CA$59m - CA$8.0m) (Based on the trailing twelve months to June 2021).
Thus, RediShred Capital has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 7.9%.
In the above chart we have measured RediShred Capital's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
In terms of RediShred Capital's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 13%, but since then they've fallen to 3.2%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
What We Can Learn From RediShred Capital's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for RediShred Capital. And the stock has done incredibly well with a 123% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for RediShred Capital (of which 1 can't be ignored!) that you should know about.
While RediShred Capital isn't earning the highest return, check out this free list of companies that are 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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