Investors Could Be Concerned With Avaya Holdings' (NYSE:AVYA) Returns On Capital
What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Avaya Holdings (NYSE:AVYA), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Avaya Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.059 = US$293m ÷ (US$6.1b - US$1.2b) (Based on the trailing twelve months to March 2021).
Thus, Avaya Holdings has an ROCE of 5.9%. Ultimately, that's a low return and it under-performs the Software industry average of 11%.
View our latest analysis for Avaya Holdings
Above you can see how the current ROCE for Avaya Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Avaya Holdings' ROCE Trending?
In terms of Avaya Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 26% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Avaya Holdings has done well to pay down its current liabilities to 19% of total assets. Considering it used to be 74%, that's a huge drop in that ratio and it would explain the decline in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
In Conclusion...
In summary, Avaya Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 24% over the last three years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Avaya Holdings does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is potentially serious...
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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