What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Although, when we looked at Ridley (ASX:RIC), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Ridley:

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

0.12 = AU$44m ÷ (AU$561m - AU$201m) (Based on the trailing twelve months to December 2021).

So, Ridley has an ROCE of 12%.  On its own, that's a standard return, however it's much better than the 6.6% generated by the Food industry.

See our latest analysis for Ridley  roce

Above you can see how the current ROCE for Ridley compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Ridley here  for free.

What The Trend Of ROCE Can Tell Us

Over the past five years, Ridley's ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So unless we see a substantial change at Ridley in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. On top of that you'll notice that Ridley has been paying out a large portion (61%) of earnings in the form of dividends to shareholders. If the company is in fact lacking growth opportunities, that's one of the viable alternatives for the money.



What We Can Learn From Ridley's ROCE

In a nutshell, Ridley has been trudging along with the same returns from the same amount of capital over the last five years. Since the stock has gained an impressive 44% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing to note, we've identified  1 warning sign  with Ridley and understanding this should be part of your investment process.

While Ridley 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 freelist 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.