To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, Frequency Electronics (NASDAQ:FEIM) looks quite promising in regards to its trends of return on capital.

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 Frequency Electronics:

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

0.12 = US$5.3m ÷ (US$84m - US$39m) (Based on the trailing twelve months to July 2024).

Therefore, Frequency Electronics has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 10.0% generated by the Electronic industry.

See our latest analysis for Frequency Electronics

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Frequency Electronics has performed in the past in other metrics, you can view this free graph of Frequency Electronics' past earnings, revenue and cash flow.

What Does the ROCE Trend For Frequency Electronics Tell Us?

We're delighted to see that Frequency Electronics is reaping rewards from its investments and has now broken into profitability. The company was generating losses five years ago, but now it's turned around, earning 12% which is no doubt a relief for some early shareholders. Additionally, the business is utilizing 49% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 46% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.