Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. So when we looked at ALS (ASX:ALQ) and its trend of ROCE, we really liked what we saw.
What is 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. To calculate this metric for ALS, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = AU$295m ÷ (AU$2.9b - AU$587m) (Based on the trailing twelve months to March 2020).
Thus, ALS has an ROCE of 13%. In absolute terms, that's a pretty standard return but compared to the Professional Services industry average it falls behind.
Above you can see how the current ROCE for ALS 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 ALS here for free.
So How Is ALS' ROCE Trending?
ALS has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 40% whilst employing roughly the same amount of capital. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 20% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
What We Can Learn From ALS' ROCE
As discussed above, ALS appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a staggering 111% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
On a separate note, we've found 3 warning signs for ALS you'll probably want to know about.
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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