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To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after investigating AB Dynamics (LON:ABDP), we don't think it's current trends fit the mold of a multi-bagger.
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 AB Dynamics is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.048 = UK£6.0m ÷ (UK£171m - UK£45m) (Based on the trailing twelve months to February 2023).
So, AB Dynamics has an ROCE of 4.8%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 9.8%.
View our latest analysis for AB Dynamics
In the above chart we have measured AB Dynamics' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for AB Dynamics.
The Trend Of ROCE
When we looked at the ROCE trend at AB Dynamics, we didn't gain much confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 4.8%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
In Conclusion...
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for AB Dynamics. These trends are starting to be recognized by investors since the stock has delivered a 17% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
One more thing to note, we've identified 1 warning sign with AB Dynamics and understanding this should be part of your investment process.
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.