If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. So when we looked at Generac Holdings (NYSE:GNRC) and its trend of ROCE, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
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. To calculate this metric for Generac Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$736m ÷ (US$5.5b - US$1.2b) (Based on the trailing twelve months to June 2022).
Therefore, Generac Holdings has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Electrical industry average of 8.0% it's much better.
In the above chart we have measured Generac Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Generac Holdings here for free.
How Are Returns Trending?
The trends we've noticed at Generac Holdings are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 17%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 173%. 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.
The Key Takeaway
To sum it up, Generac Holdings has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And a remarkable 597% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing to note, we've identified 1 warning sign with Generac Holdings and understanding it should be part of your investment process.
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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