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. 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 Pure Cycle (NASDAQ:PCYO) and its trend of ROCE, we really liked what we saw.

Understanding 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. To calculate this metric for Pure Cycle, this is the formula:

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

0.086 = US$12m ÷ (US$150m - US$7.9m) (Based on the trailing twelve months to November 2024).

So, Pure Cycle has an ROCE of 8.6%. In absolute terms, that's a low return, but it's much better than the Water Utilities industry average of 4.8%.

See our latest analysis for Pure Cycle

Historical performance is a great place to start when researching a stock so above you can see the gauge for Pure Cycle's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Pure Cycle.

What Can We Tell From Pure Cycle's ROCE Trend?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. Over the last five years, returns on capital employed have risen substantially to 8.6%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 74%. So we're very much inspired by what we're seeing at Pure Cycle thanks to its ability to profitably reinvest capital.

The Key Takeaway

To sum it up, Pure Cycle has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Given the stock has declined 11% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.

If you want to continue researching Pure Cycle, you might be interested to know about the 1 warning sign that our analysis has discovered.

While Pure Cycle 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.