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. In light of that, when we looked at ARB (ASX:ARB) and its ROCE trend, we weren’t exactly thrilled.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you’re unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on ARB is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.19 = AU$80m ÷ (AU$487m – AU$73m) (Based on the trailing twelve months to June 2020).
So, ARB has an ROCE of 19%. In absolute terms, that’s a satisfactory return, but compared to the Auto Components industry average of 15% it’s much better.
Check out our latest analysis for ARB
In the above chart we have measured ARB’s prior ROCE against its prior performance, but the future is arguably more important. If you’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
On the surface, the trend of ROCE at ARB doesn’t inspire confidence. To be more specific, ROCE has fallen from 25% over the last five years. However it looks like ARB 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’s worth keeping an eye on the company’s earnings from here on to see if these investments do end up contributing to the bottom line.
The Key Takeaway
Bringing it all together, while we’re somewhat encouraged by ARB’s reinvestment in its own business, we’re aware that returns are shrinking. Investors must think there’s better things to come because the stock has knocked it out of the park, delivering a 142% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn’t get our hopes up too high.
If you’re still interested in ARB it’s worth checking out our FREE intrinsic value approximation to see if it’s trading at an attractive price in other respects.
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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This article by Simply Wall St is general in nature. 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.
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