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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at Adrad Holdings (ASX:AHL) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Adrad Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.063 = AU$10m ÷ (AU$191m - AU$25m) (Based on the trailing twelve months to June 2024).
Thus, Adrad Holdings has an ROCE of 6.3%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 11%.
View our latest analysis for Adrad Holdings
Above you can see how the current ROCE for Adrad Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Adrad Holdings for free.
So How Is Adrad Holdings' ROCE Trending?
On the surface, the trend of ROCE at Adrad Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 17% over the last three years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a side note, Adrad Holdings has done well to pay down its current liabilities to 13% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Adrad Holdings' reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 12% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Adrad Holdings has the makings of a multi-bagger.