There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Educational Development's (NASDAQ:EDUC) returns on capital, so let's have a look.
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. To calculate this metric for Educational Development, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.31 = US$16m ÷ (US$89m - US$38m) (Based on the trailing twelve months to February 2021).
Therefore, Educational Development has an ROCE of 31%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.
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're interested in investigating Educational Development's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
We like the trends that we're seeing from Educational Development. The data shows that returns on capital have increased substantially over the last five years to 31%. Basically the business is earning more per dollar of capital invested and in addition to that, 65% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
Another thing to note, Educational Development has a high ratio of current liabilities to total assets of 43%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line On Educational Development's ROCE
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Educational Development has. 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.
Like most companies, Educational Development does come with some risks, and we've found 3 warning signs that you should be aware of.
Educational Development 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.
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.
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