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To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Looking at Character Group (LON:CCT), it does have a high ROCE right now, but lets see how returns are trending.
Understanding 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. Analysts use this formula to calculate it for Character Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = UK£11m ÷ (UK£87m - UK£41m) (Based on the trailing twelve months to August 2021).
So, Character Group has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Leisure industry average of 18%.
Check out our latest analysis for Character Group
In the above chart we have measured Character Group'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 Character Group.
What The Trend Of ROCE Can Tell Us
In terms of Character Group's historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 58%, but they have dropped over the last five years. 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.
On a related note, Character Group has decreased its current liabilities to 47% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
What We Can Learn From Character Group's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Character Group is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 50% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.