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. Firstly, we’d want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Although, when we looked at Avarga (SGX:U09), it didn’t seem to tick all of these boxes.
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. The formula for this calculation on Avarga is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.093 = S$53m ÷ (S$728m – S$152m) (Based on the trailing twelve months to June 2024).
Thus, Avarga has an ROCE of 9.3%. On its own that’s a low return, but compared to the average of 7.1% generated by the Forestry industry, it’s much better.
See our latest analysis for Avarga
Historical performance is a great place to start when researching a stock so above you can see the gauge for Avarga’s ROCE against it’s prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Avarga.
How Are Returns Trending?
There are better returns on capital out there than what we’re seeing at Avarga. The company has consistently earned 9.3% for the last five years, and the capital employed within the business has risen 42% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don’t provide a high return on capital.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 21% of total assets, is good to see from a business owner’s perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.
The Key Takeaway
As we’ve seen above, Avarga’s returns on capital haven’t increased but it is reinvesting in the business. Unsurprisingly, the stock has only gained 30% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you’re hunting for a multi-bagger, we think you’d have more luck elsewhere.
One more thing: We’ve identified 3 warning signs with Avarga (at least 1 which is concerning) , and understanding them would certainly be useful.
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.
