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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. And in light of that, the trends we're seeing at Atlas Pearls' (ASX:ATP) look very promising so lets take a look.
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. To calculate this metric for Atlas Pearls, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.38 = AU$8.0m ÷ (AU$28m - AU$6.9m) (Based on the trailing twelve months to June 2021).
So, Atlas Pearls has an ROCE of 38%. That's a fantastic return and not only that, it outpaces the average of 9.9% 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 want to delve into the historical earnings, revenue and cash flow of Atlas Pearls, check out these free graphs here.
What Does the ROCE Trend For Atlas Pearls Tell Us?
You'd find it hard not to be impressed with the ROCE trend at Atlas Pearls. The figures show that over the last five years, returns on capital have grown by 511%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Interestingly, the business may be becoming more efficient because it's applying 22% less capital than it was five years ago. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.
The Key Takeaway
From what we've seen above, Atlas Pearls has managed to increase it's returns on capital all the while reducing it's capital base. And since the stock has fallen 30% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Atlas Pearls (of which 2 make us uncomfortable!) that you should know about.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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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