If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Extendicare's (TSE:EXE) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Extendicare is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.32 = CA$196m ÷ (CA$900m - CA$282m) (Based on the trailing twelve months to December 2021).
So, Extendicare has an ROCE of 32%. That's a fantastic return and not only that, it outpaces the average of 8.2% earned by companies in a similar industry.
Check out our latest analysis for Extendicare
Above you can see how the current ROCE for Extendicare 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 Extendicare here for free.
So How Is Extendicare's ROCE Trending?
Extendicare has not disappointed in regards to ROCE growth. The data shows that returns on capital have increased by 301% 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. In regards to capital employed, Extendicare appears to been achieving more with less, since the business is using 21% less capital to run its operation. Extendicare may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 31% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
What We Can Learn From Extendicare's ROCE
In summary, it's great to see that Extendicare has been able to turn things around and earn higher returns on lower amounts of capital. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
Extendicare does have some risks, we noticed 5 warning signs (and 3 which are concerning) we think you should know about.
Extendicare is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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.