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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at AdvanSix (NYSE:ASIX), it didn't seem to tick all of these boxes.
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 AdvanSix, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.018 = US$18m ÷ (US$1.2b - US$253m) (Based on the trailing twelve months to September 2020).
Therefore, AdvanSix has an ROCE of 1.8%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 8.1%.
In the above chart we have measured AdvanSix'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 AdvanSix here for free.
How Are Returns Trending?
In terms of AdvanSix's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 1.8% from 18% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
What We Can Learn From AdvanSix's ROCE
In summary, we're somewhat concerned by AdvanSix's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 55% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
On a final note, we found 4 warning signs for AdvanSix (1 shouldn't be ignored) you should be aware of.
While AdvanSix 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.
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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