Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 on that note, PolyNovo (ASX:PNV) looks quite promising in regards to its trends of return on capital.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for PolyNovo:

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

0.01 = AU$897k ÷ (AU$109m - AU$23m) (Based on the trailing twelve months to June 2024).

So, PolyNovo has an ROCE of 1.0%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 6.9%.

View our latest analysis for PolyNovo

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

What The Trend Of ROCE Can Tell Us

PolyNovo has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 1.0% on its capital. In addition to that, PolyNovo is employing 227% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

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 21% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

What We Can Learn From PolyNovo's ROCE

In summary, it's great to see that PolyNovo has managed to break into profitability and is continuing to reinvest in its business. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. So researching this company further and determining whether or not these trends will continue seems justified.

One more thing, we've spotted 1 warning sign facing PolyNovo that you might find interesting.

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

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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.