There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Although, when we looked at Farmmi (NASDAQ:FAMI), 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. The formula for this calculation on Farmmi is:

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

0.0045 = US$796k ÷ (US$187m - US$10m) (Based on the trailing twelve months to September 2024).

So, Farmmi has an ROCE of 0.5%. In absolute terms, that's a low return and it also under-performs the Food industry average of 10%.

Check out our latest analysis for Farmmi

Historical performance is a great place to start when researching a stock so above you can see the gauge for Farmmi's ROCE against it's prior returns. If you're interested in investigating Farmmi's past further, check out this free graph covering Farmmi's past earnings, revenue and cash flow.

How Are Returns Trending?

We weren't thrilled with the trend because Farmmi's ROCE has reduced by 97% over the last five years, while the business employed 691% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Farmmi might not have received a full period of earnings contribution from it.

On a side note, Farmmi has done well to pay down its current liabilities to 5.4% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

We're a bit apprehensive about Farmmi because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Unsurprisingly then, the stock has dived 100% over the last five years, so investors are recognizing these changes and don't like the company's prospects. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 3 warning signs with Farmmi (at least 2 which are concerning) , and understanding them would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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