Adacel Technologies (ASX:ADA) Could Be Struggling To Allocate Capital
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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Adacel Technologies (ASX:ADA) and its ROCE trend, we weren't exactly thrilled.
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. Analysts use this formula to calculate it for Adacel Technologies:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = AU$3.6m ÷ (AU$37m - AU$13m) (Based on the trailing twelve months to December 2020).
Thus, Adacel Technologies has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Software industry average of 14%.
View our latest analysis for Adacel Technologies
In the above chart we have measured Adacel Technologies' 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.
How Are Returns Trending?
On the surface, the trend of ROCE at Adacel Technologies doesn't inspire confidence. Over the last five years, returns on capital have decreased to 15% from 54% five years ago. However it looks like Adacel Technologies 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 may take some time before the company starts to see any change in earnings from these investments.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Adacel Technologies' reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 66% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
If you want to know some of the risks facing Adacel Technologies we've found 3 warning signs (1 is potentially serious!) that you should be aware of before investing here.
While Adacel Technologies may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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