To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Medifast (NYSE:MED), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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 Medifast is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.36 = US$81m ÷ (US$303m - US$77m) (Based on the trailing twelve months to March 2024).

Thus, Medifast has an ROCE of 36%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.

In the above chart we have measured Medifast'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 Medifast for free.

The Trend Of ROCE

When we looked at the ROCE trend at Medifast, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 59% where it was five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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.

On a related note, Medifast has decreased its current liabilities to 25% of total assets. That could partly explain why the ROCE has dropped. 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.

In Conclusion...

We're a bit apprehensive about Medifast because despite more capital being deployed in the business, returns on that capital and sales have both fallen. We expect this has contributed to the stock plummeting 77% during the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing: We've identified 2 warning signs with Medifast (at least 1 which is concerning) , and understanding them would certainly be useful.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.