If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after briefly looking over the numbers, we don't think Orica (ASX:ORI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on Orica is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.09 = AU$532m ÷ (AU$8.4b - AU$2.5b) (Based on the trailing twelve months to September 2022).
So, Orica has an ROCE of 9.0%. On its own, that's a low figure but it's around the 10% average generated by the Chemicals industry.
View our latest analysis for Orica
Above you can see how the current ROCE for Orica compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
Over the past five years, Orica's ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So unless we see a substantial change at Orica in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. This probably explains why Orica is paying out 47% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 30% of total assets, this reported ROCE would probably be less than9.0% because total capital employed would be higher.The 9.0% ROCE could be even lower if current liabilities weren't 30% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.
The Bottom Line On Orica's ROCE
In summary, Orica isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Unsurprisingly then, the total return to shareholders over the last five years has been flat. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
Orica does have some risks though, and we've spotted 2 warning signs for Orica that you might be interested in.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.
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