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If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, AAR (NYSE:AIR) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for AAR, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.013 = US$16m ÷ (US$1.7b - US$408m) (Based on the trailing twelve months to November 2020).
Thus, AAR has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Aerospace & Defense industry average of 8.5%.
Above you can see how the current ROCE for AAR compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for AAR.
What The Trend Of ROCE Can Tell Us
Shareholders will be relieved that AAR has broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 1.3% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
The Bottom Line On AAR's ROCE
As discussed above, AAR appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 95% return over the last five years. Therefore, we think it would be worth your time to check if these trends are going to continue.
On a final note, we've found 2 warning signs for AAR that we think you should be aware of.
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.
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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