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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at the ROCE trend of Argan (NYSE:AGX) we really liked what we saw.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Argan is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = US$67m ÷ (US$769m - US$436m) (Based on the trailing twelve months to October 2024).
Thus, Argan has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Construction industry average of 13%.
Check out our latest analysis for Argan
In the above chart we have measured Argan's 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 analyst report for Argan .
What The Trend Of ROCE Can Tell Us
Shareholders will be relieved that Argan has broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 20% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. Because in the end, a business can only get so efficient.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 57% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
The Bottom Line
To sum it up, Argan is collecting higher returns from the same amount of capital, and that's impressive. Since the stock has returned a staggering 311% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.