Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. In light of that, when we looked at Exchange Income (TSE:EIF) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Exchange Income, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.072 = CA$212m ÷ (CA$3.5b - CA$499m) (Based on the trailing twelve months to September 2022).
So, Exchange Income has an ROCE of 7.2%. On its own, that's a low figure but it's around the 6.4% average generated by the Airlines industry.
In the above chart we have measured Exchange Income's 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 Exchange Income here for free.
So How Is Exchange Income's ROCE Trending?
There are better returns on capital out there than what we're seeing at Exchange Income. The company has employed 117% more capital in the last five years, and the returns on that capital have remained stable at 7.2%. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
The Bottom Line
In conclusion, Exchange Income has been investing more capital into the business, but returns on that capital haven't increased. Since the stock has gained an impressive 91% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you want to know some of the risks facing Exchange Income we've found 2 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
While Exchange Income may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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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