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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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 Algoma Central's (TSE:ALC) returns on capital, so let's have a look.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Algoma Central, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.089 = CA$97m ÷ (CA$1.2b - CA$91m) (Based on the trailing twelve months to March 2022).
Thus, Algoma Central has an ROCE of 8.9%. In absolute terms, that's a low return and it also under-performs the Shipping industry average of 17%.
In the above chart we have measured Algoma Central'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 Algoma Central here for free.
What The Trend Of ROCE Can Tell Us
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. Over the last five years, returns on capital employed have risen substantially to 8.9%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 28%. 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 Algoma Central's ROCE
In summary, it's great to see that Algoma Central 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. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 89% return over the last five years. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
If you'd like to know about the risks facing Algoma Central, we've discovered 2 warning signs 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.
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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.