If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Generac Holdings (NYSE:GNRC), it didn't seem to tick all of these boxes.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Generac Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.081 = US$344m ÷ (US$5.2b - US$900m) (Based on the trailing twelve months to September 2023).
Therefore, Generac Holdings has an ROCE of 8.1%. Ultimately, that's a low return and it under-performs the Electrical industry average of 14%.
Check out our latest analysis for Generac Holdings
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.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Generac Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 19% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
What We Can Learn From Generac Holdings' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Generac Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 87% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Generac Holdings does have some risks, we noticed 2 warning signs (and 1 which is significant) we think you should know about.
While Generac Holdings 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.