If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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 ALS' (ASX:ALQ) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on ALS is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = AU$356m ÷ (AU$2.8b - AU$739m) (Based on the trailing twelve months to March 2022).
So, ALS has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Professional Services industry average of 13% it's much better.
Check out our latest analysis for ALS
In the above chart we have measured ALS' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
ALS' ROCE growth is quite impressive. The figures show that over the last five years, ROCE has grown 77% whilst employing roughly the same amount of capital. 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. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 26% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
What We Can Learn From ALS' ROCE
To sum it up, ALS is collecting higher returns from the same amount of capital, and that's impressive. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 46% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing, we've spotted 2 warning signs facing ALS that you might find interesting.
While ALS may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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