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To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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 Allied Farmers (NZSE:ALF), it didn't seem to tick all of these boxes.
What Is Return On Capital Employed (ROCE)?
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 Allied Farmers is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = NZ$4.4m ÷ (NZ$31m - NZ$7.1m) (Based on the trailing twelve months to December 2023).
So, Allied Farmers has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 9.7% it's much better.
See our latest analysis for Allied Farmers
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Allied Farmers' past further, check out this free graph covering Allied Farmers' past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Allied Farmers doesn't inspire confidence. To be more specific, ROCE has fallen from 53% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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 related note, Allied Farmers has decreased its current liabilities to 23% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
Our Take On Allied Farmers' ROCE
To conclude, we've found that Allied Farmers is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 21% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.