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What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at Velan (TSE:VLN) so let's look a bit deeper.
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 Velan:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$40m ÷ (US$510m - US$302m) (Based on the trailing twelve months to November 2024).
Thus, Velan has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 11% it's much better.
Check out our latest analysis for Velan
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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Velan.
How Are Returns Trending?
Velan has not disappointed in regards to ROCE growth. The data shows that returns on capital have increased by 900% over the trailing five years. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 38% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 59% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
The Bottom Line
In the end, Velan has proven it's capital allocation skills are good with those higher returns from less amount of capital. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.