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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Speaking of which, we noticed some great changes in American Vanguard's (NYSE:AVD) returns on capital, so let's have a look.
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. To calculate this metric for American Vanguard, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.047 = US$25m ÷ (US$661m - US$132m) (Based on the trailing twelve months to June 2020).
So, American Vanguard has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 9.3%.
In the above chart we have measured American Vanguard's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering American Vanguard here for free.
So How Is American Vanguard's ROCE Trending?
While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 4.7%. Basically the business is earning more per dollar of capital invested and in addition to that, 39% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
What We Can Learn From American Vanguard's ROCE
In summary, it's great to see that American Vanguard can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the stock has only returned 15% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
American Vanguard does have some risks though, and we've spotted 3 warning signs for American Vanguard that you might be interested in.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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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