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To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, H2O Innovation (TSE:HEO) looks quite promising in regards to its trends of return on capital.
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. Analysts use this formula to calculate it for H2O Innovation:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.046 = CA$6.3m ÷ (CA$173m - CA$36m) (Based on the trailing twelve months to March 2022).
So, H2O Innovation has an ROCE of 4.6%. Even though it's in line with the industry average of 5.3%, it's still a low return by itself.
Above you can see how the current ROCE for H2O Innovation 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 H2O Innovation.
The Trend Of ROCE
H2O Innovation has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 4.6% on its capital. In addition to that, H2O Innovation is employing 145% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
Our Take On H2O Innovation's ROCE
In summary, it's great to see that H2O Innovation has managed to break into profitability and is continuing to reinvest in its business. Since the stock has only returned 37% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So with that in mind, we think the stock deserves further research.
On a separate note, we've found 2 warning signs for H2O Innovation you'll probably want to know about.
While H2O Innovation isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.