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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in ADT's (NYSE:ADT) returns on capital, so let's have a look.
What is 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. Analysts use this formula to calculate it for ADT:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.013 = US$195m ÷ (US$16b - US$1.2b) (Based on the trailing twelve months to September 2020).
Therefore, ADT has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 9.9%.
In the above chart we have measured ADT's 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.
The Trend Of ROCE
While the ROCE isn't as high as some other companies out there, it's great to see it's on the up. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 29% over the last four years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
What We Can Learn From ADT's ROCE
To bring it all together, ADT has done well to increase the returns it's generating from its capital employed. Astute investors may have an opportunity here because the stock has declined 19% in the last three years. So researching this company further and determining whether or not these trends will continue seems justified.
On a final note, we've found 2 warning signs for ADT that we think you should be aware of.
While ADT isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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