What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. So when we looked at Patterson Companies (NASDAQ:PDCO) and its trend of ROCE, we really liked what we saw.
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. The formula for this calculation on Patterson Companies is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$258m ÷ (US$2.9b - US$1.4b) (Based on the trailing twelve months to July 2024).
Therefore, Patterson Companies has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Healthcare industry average of 10% it's much better.
In the above chart we have measured Patterson Companies' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Patterson Companies .
How Are Returns Trending?
Patterson Companies has not disappointed in regards to ROCE growth. We found that the returns on capital employed over the last five years have risen by 139%. The company is now earning US$0.2 per dollar of capital employed. In regards to capital employed, Patterson Companies appears to been achieving more with less, since the business is using 39% less capital to run its operation. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 47% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
In Conclusion...
From what we've seen above, Patterson Companies has managed to increase it's returns on capital all the while reducing it's capital base. Since the stock has only returned 39% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
One final note, you should learn about the 3 warning signs we've spotted with Patterson Companies (including 2 which are potentially serious) .
While Patterson Companies 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.
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.
