Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Amiad Water Systems (LON:AFS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is Return On Capital Employed (ROCE)?
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 Amiad Water Systems is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.051 = US$5.4m ÷ (US$145m - US$39m) (Based on the trailing twelve months to December 2020).
Thus, Amiad Water Systems has an ROCE of 5.1%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 8.4%.
Check out our latest analysis for Amiad Water Systems
In the above chart we have measured Amiad Water Systems' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Amiad Water Systems here for free.
So How Is Amiad Water Systems' ROCE Trending?
We weren't thrilled with the trend because Amiad Water Systems' ROCE has reduced by 59% over the last five years, while the business employed 52% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Amiad Water Systems probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.
On a side note, Amiad Water Systems has done well to pay down its current liabilities to 27% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.