If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. However, after briefly looking over the numbers, we don't think Schaffer (ASX:SFC) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is 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 Schaffer:

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

0.081 = AU$27m ÷ (AU$412m - AU$74m) (Based on the trailing twelve months to June 2023).

So, Schaffer has an ROCE of 8.1%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 11%.

See our latest analysis for Schaffer

Historical performance is a great place to start when researching a stock so above you can see the gauge for Schaffer's ROCE against it's prior returns. If you'd like to look at how Schaffer has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Schaffer Tell Us?

When we looked at the ROCE trend at Schaffer, we didn't gain much confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 8.1%. However it looks like Schaffer might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Schaffer's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 78% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing: We've identified 2 warning signs with Schaffer (at least 1 which is a bit unpleasant) , and understanding them would certainly be useful.