If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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 McMillan Shakespeare (ASX:MMS), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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. To calculate this metric for McMillan Shakespeare, this is the formula:

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

0.22 = AU$156m ÷ (AU$1.3b - AU$581m) (Based on the trailing twelve months to June 2024).

Thus, McMillan Shakespeare has an ROCE of 22%. On its own, that's a very good return and it's on par with the returns earned by companies in a similar industry.

See our latest analysis for McMillan Shakespeare

Above you can see how the current ROCE for McMillan Shakespeare compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for McMillan Shakespeare .

So How Is McMillan Shakespeare's ROCE Trending?

There hasn't been much to report for McMillan Shakespeare's returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So it may not be a multi-bagger in the making, but given the decent 22% return on capital, it'd be difficult to find fault with the business's current operations. That probably explains why McMillan Shakespeare has been paying out 97% of its earnings as dividends to shareholders. Most shareholders probably know this and own the stock for its dividend.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 45% of total assets, this reported ROCE would probably be less than22% because total capital employed would be higher.The 22% ROCE could be even lower if current liabilities weren't 45% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

What We Can Learn From McMillan Shakespeare's ROCE

Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. Although the market must be expecting these trends to improve because the stock has gained 61% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you want to continue researching McMillan Shakespeare, you might be interested to know about the 3 warning signs that our analysis has discovered.

McMillan Shakespeare is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.