What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Austin Engineering's (ASX:ANG) returns on capital, so let's have a look.
Understanding 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. Analysts use this formula to calculate it for Austin Engineering:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = AU$16m ÷ (AU$184m - AU$80m) (Based on the trailing twelve months to December 2021).
So, Austin Engineering has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 9.6% generated by the Machinery industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Austin Engineering's ROCE against it's prior returns. If you're interested in investigating Austin Engineering's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Austin Engineering Tell Us?
It's great to see that Austin Engineering has started to generate some pre-tax earnings from prior investments. While the business is profitable now, it used to be incurring losses on invested capital five years ago. At first glance, it seems the business is getting more proficient at generating returns, because over the same period, the amount of capital employed has reduced by 41%. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 43% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. And with current liabilities at those levels, that's pretty high.
In summary, it's great to see that Austin Engineering has been able to turn things around and earn higher returns on lower amounts of capital. Considering the stock has delivered 24% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So with that in mind, we think the stock deserves further research.
If you want to continue researching Austin Engineering, you might be interested to know about the 2 warning signs that our analysis has discovered.
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.
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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.
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