Advanced Drainage Systems (NYSE:WMS) Is Very Good At Capital Allocation
If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. And in light of that, the trends we're seeing at Advanced Drainage Systems' (NYSE:WMS) look very promising so lets take a look.
Understanding Return On Capital Employed (ROCE)
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. Analysts use this formula to calculate it for Advanced Drainage Systems:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = US$725m ÷ (US$2.9b - US$379m) (Based on the trailing twelve months to March 2023).
Therefore, Advanced Drainage Systems has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Building industry average of 15%.
See our latest analysis for Advanced Drainage Systems
Above you can see how the current ROCE for Advanced Drainage Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Advanced Drainage Systems here for free.
The Trend Of ROCE
Investors would be pleased with what's happening at Advanced Drainage Systems. Over the last five years, returns on capital employed have risen substantially to 29%. The amount of capital employed has increased too, by 207%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
In Conclusion...
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Advanced Drainage Systems has. Since the stock has returned a staggering 319% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Advanced Drainage Systems can keep these trends up, it could have a bright future ahead.
One more thing to note, we've identified 2 warning signs with Advanced Drainage Systems and understanding them should be part of your investment process.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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.
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