If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. 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 ZoomerMedia (CVE:ZUM), it didn't seem to tick all of these boxes.
What is 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 ZoomerMedia, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.059 = CA$4.3m ÷ (CA$88m - CA$14m) (Based on the trailing twelve months to November 2021).
Therefore, ZoomerMedia has an ROCE of 5.9%. In absolute terms, that's a low return and it also under-performs the Media industry average of 9.6%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how ZoomerMedia has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From ZoomerMedia's ROCE Trend?
In terms of ZoomerMedia's historical ROCE trend, it doesn't exactly demand attention. The company has employed 50% more capital in the last five years, and the returns on that capital have remained stable at 5.9%. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
The Bottom Line
As we've seen above, ZoomerMedia's returns on capital haven't increased but it is reinvesting in the business. Since the stock has gained an impressive 67% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
One more thing: We've identified 5 warning signs with ZoomerMedia (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.
While ZoomerMedia may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.