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. 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. Having said that, from a first glance at Pacific Smiles Group (ASX:PSQ) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on Pacific Smiles Group is:

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

0.12 = AU$15m ÷ (AU$161m - AU$37m) (Based on the trailing twelve months to June 2021).

So, Pacific Smiles Group has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Healthcare industry average of 8.5% it's much better.

See our latest analysis for Pacific Smiles Group

In the above chart we have measured Pacific Smiles Group'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 Pacific Smiles Group here for free.

So How Is Pacific Smiles Group's ROCE Trending?

On the surface, the trend of ROCE at Pacific Smiles Group doesn't inspire confidence. Around five years ago the returns on capital were 26%, but since then they've fallen to 12%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Pacific Smiles Group. In light of this, the stock has only gained 24% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Pacific Smiles Group does have some risks though, and we've spotted 2 warning signs for Pacific Smiles Group that you might be interested in.

While Pacific Smiles Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.

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