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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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Speaking of which, we noticed some great changes in Bowl America's (NYSEMKT:BWL.A) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Bowl America:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.069 = US$1.8m ÷ (US$30m - US$3.4m) (Based on the trailing twelve months to March 2020).
Therefore, Bowl America has an ROCE of 6.9%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.4%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Bowl America's ROCE against it's prior returns. If you'd like to look at how Bowl America has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
Bowl America's ROCE growth is quite impressive. 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 34% over the last five 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. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.
The Bottom Line
In summary, we're delighted to see that Bowl America has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Given the stock has declined 15% in the last five years, there could be a chance of a good investment here if the valuation makes sense. So researching this company further and determining whether or not these trends will continue seems justified.
If you want to continue researching Bowl America, you might be interested to know about the 2 warning signs that our analysis has discovered.
While Bowl America 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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