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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Aferian (LON:AFRN) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 Aferian is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.066 = US$7.2m ÷ (US$138m - US$30m) (Based on the trailing twelve months to November 2021).
Thus, Aferian has an ROCE of 6.6%. Ultimately, that's a low return and it under-performs the Communications industry average of 8.4%.
See our latest analysis for Aferian
In the above chart we have measured Aferian's 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 Aferian.
What Does the ROCE Trend For Aferian Tell Us?
On the surface, the trend of ROCE at Aferian doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.6% from 15% five years ago. 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.
On a related note, Aferian has decreased its current liabilities to 21% of total assets. So we could link some of this to the decrease in ROCE. 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 Key Takeaway
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Aferian. And there could be an opportunity here if other metrics look good too, because the stock has declined 21% in the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.