Has Shriro Holdings (ASX:SHM) Got What It Takes To Become A Multi-Bagger?
Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after briefly looking over the numbers, we don't think Shriro Holdings (ASX:SHM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 Shriro Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = AU$15m ÷ (AU$102m - AU$29m) (Based on the trailing twelve months to June 2020).
Therefore, Shriro Holdings has an ROCE of 20%. That's a relatively normal return on capital, and it's around the 24% generated by the Consumer Durables industry.
View our latest analysis for Shriro Holdings
Above you can see how the current ROCE for Shriro Holdings 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.
What The Trend Of ROCE Can Tell Us
In terms of Shriro Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 20% from 32% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
On a related note, Shriro Holdings has decreased its current liabilities to 28% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
Our Take On Shriro Holdings' ROCE
Bringing it all together, while we're somewhat encouraged by Shriro Holdings' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 48% 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.
One more thing to note, we've identified 3 warning signs with Shriro Holdings and understanding them 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.
This article by Simply Wall St is general in nature. 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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