If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Primero Group (ASX:PGX) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding 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. To calculate this metric for Primero Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = AU$7.8m ÷ (AU$119m - AU$67m) (Based on the trailing twelve months to June 2020).
So, Primero Group has an ROCE of 15%. By itself that's a normal return on capital and it's in line with the industry's average returns of 15%.
View our latest analysis for Primero Group
In the above chart we have measured Primero 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 Primero Group.
How Are Returns Trending?
When we looked at the ROCE trend at Primero Group, we didn't gain much confidence. Over the last three years, returns on capital have decreased to 15% from 39% three years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, Primero Group has decreased its current liabilities to 57% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 57% is still pretty high, so those risks are still somewhat prevalent.
What We Can Learn From Primero Group's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Primero Group is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 23% over the last year, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
Primero Group does have some risks, we noticed 4 warning signs (and 1 which is concerning) we think you should know about.
While Primero Group 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.
This article by Simply Wall St is general in nature. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.