There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at REV Group (NYSE:REVG) and its ROCE trend, we weren't exactly thrilled.
What Is 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. The formula for this calculation on REV Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.086 = US$72m ÷ (US$1.4b - US$548m) (Based on the trailing twelve months to July 2023).
Therefore, REV Group has an ROCE of 8.6%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 12%.
View our latest analysis for REV Group
Above you can see how the current ROCE for REV Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
We're a bit concerned with the trends, because the business is applying 21% less capital than it was five years ago and returns on that capital have stayed flat. To us that doesn't look like a multi-bagger because the company appears to be selling assets and it's returns aren't increasing. In addition to that, since the ROCE doesn't scream "quality" at 8.6%, it's hard to get excited about these developments.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 40% of total assets, this reported ROCE would probably be less than8.6% because total capital employed would be higher.The 8.6% ROCE could be even lower if current liabilities weren't 40% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.
The Key Takeaway
It's a shame to see that REV Group is effectively shrinking in terms of its capital base. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 103% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
REV Group does have some risks though, and we've spotted 1 warning sign for REV Group that you might be interested in.
While REV Group 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.