If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Objective (ASX:OCL), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
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 Objective, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.34 = AU$24m ÷ (AU$125m - AU$56m) (Based on the trailing twelve months to December 2022).
So, Objective has an ROCE of 34%. In absolute terms that's a great return and it's even better than the Software industry average of 12%.
View our latest analysis for Objective
Above you can see how the current ROCE for Objective compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Objective here for free.
The Trend Of ROCE
When we looked at the ROCE trend at Objective, we didn't gain much confidence. Historically returns on capital were even higher at 46%, but they have dropped over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Objective's current liabilities are still rather high at 45% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by Objective's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 285% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.