If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Avnet's (NASDAQ:AVT) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What Is It?
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 Avnet:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = US$1.1b ÷ (US$11b - US$4.7b) (Based on the trailing twelve months to October 2022).
Thus, Avnet has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 13% it's much better.
Above you can see how the current ROCE for Avnet compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Avnet.
What Can We Tell From Avnet's ROCE Trend?
Avnet's ROCE growth is quite impressive. The figures show that over the last five years, ROCE has grown 123% whilst employing roughly the same amount of capital. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 42% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
The Bottom Line
In summary, we're delighted to see that Avnet has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 14% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
Avnet does come with some risks though, we found 5 warning signs in our investment analysis, and 3 of those are a bit concerning...
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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