If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Aeris Environmental's (ASX:AEI) returns on capital, so let's have a look.
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. Analysts use this formula to calculate it for Aeris Environmental:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.073 = AU$1.4m ÷ (AU$23m - AU$3.0m) (Based on the trailing twelve months to June 2020).
So, Aeris Environmental has an ROCE of 7.3%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 12%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Aeris Environmental's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Aeris Environmental, check out these free graphs here.
How Are Returns Trending?
We're delighted to see that Aeris Environmental is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 7.3% on its capital. Not only that, but the company is utilizing 224% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
One more thing to note, Aeris Environmental has decreased current liabilities to 13% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
The Bottom Line On Aeris Environmental's ROCE
Long story short, we're delighted to see that Aeris Environmental's reinvestment activities have paid off and the company is now profitable. Since the stock has returned a solid 58% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. In light of that, we think it's worth looking further into this stock because if Aeris Environmental can keep these trends up, it could have a bright future ahead.
Aeris Environmental does come with some risks though, we found 5 warning signs in our investment analysis, and 1 of those shouldn't be ignored...
While Aeris Environmental 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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