What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 investigating Linamar (TSE:LNR), we don’t think it’s current trends fit the mold of a multi-bagger.
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. Analysts use this formula to calculate it for Linamar:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.088 = CA$565m ÷ (CA$8.6b – CA$2.2b) (Based on the trailing twelve months to December 2022).
So, Linamar has an ROCE of 8.8%. Even though it’s in line with the industry average of 8.8%, it’s still a low return by itself.
View our latest analysis for Linamar
Above you can see how the current ROCE for Linamar 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.
How Are Returns Trending?
In terms of Linamar’s historical ROCE movements, the trend isn’t fantastic. Over the last five years, returns on capital have decreased to 8.8% from 16% five years ago. 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.
What We Can Learn From Linamar’s ROCE
While returns have fallen for Linamar in recent times, we’re encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 12% in the last five years. So we think it’d be worthwhile to look further into this stock given the trends look encouraging.
Linamar does have some risks, we noticed 2 warning signs (and 1 which shouldn’t be ignored) we think you should know about.
While Linamar isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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