There Are Reasons To Feel Uneasy About AB Dynamics' (LON:ABDP) Returns On Capital
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. 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 AB Dynamics (LON:ABDP), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
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 AB Dynamics is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = UK£5.2m ÷ (UK£141m - UK£23m) (Based on the trailing twelve months to August 2022).
So, AB Dynamics has an ROCE of 4.4%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 7.3%.
Check out our latest analysis for AB Dynamics
In the above chart we have measured AB Dynamics' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is AB Dynamics' ROCE Trending?
On the surface, the trend of ROCE at AB Dynamics doesn't inspire confidence. Around five years ago the returns on capital were 16%, but since then they've fallen to 4.4%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
In Conclusion...
While returns have fallen for AB Dynamics in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 109% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
Like most companies, AB Dynamics does come with some risks, and we've found 1 warning sign that you should be aware of.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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