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. 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 Ava Risk Group's (ASX:AVA) returns on capital, so let's have a look.
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. The formula for this calculation on Ava Risk Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.011 = AU$323k ÷ (AU$37m - AU$6.5m) (Based on the trailing twelve months to June 2023).
So, Ava Risk Group has an ROCE of 1.1%. Ultimately, that's a low return and it under-performs the Electronic industry average of 16%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Ava Risk Group's ROCE against it's prior returns. If you'd like to look at how Ava Risk Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
We're delighted to see that Ava Risk Group is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 1.1% which is a sight for sore eyes. Not only that, but the company is utilizing 27% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
The Key Takeaway
Overall, Ava Risk Group gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And with a respectable 64% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. Therefore, we think it would be worth your time to check if these trends are going to continue.
Ava Risk Group does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is potentially serious...
While Ava Risk Group 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.
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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.