In This Article:
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Speaking of which, we noticed some great changes in Avarga's (SGX:U09) returns on capital, so let's have a look.
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 Avarga:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = S$127m ÷ (S$726m - S$187m) (Based on the trailing twelve months to December 2022).
So, Avarga has an ROCE of 24%. That's a fantastic return and not only that, it outpaces the average of 8.6% earned by companies in a similar industry.
See our latest analysis for Avarga
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 want to delve into the historical earnings, revenue and cash flow of Avarga, check out these free graphs here.
How Are Returns Trending?
Investors would be pleased with what's happening at Avarga. Over the last five years, returns on capital employed have risen substantially to 24%. The amount of capital employed has increased too, by 68%. So we're very much inspired by what we're seeing at Avarga thanks to its ability to profitably reinvest capital.
One more thing to note, Avarga has decreased current liabilities to 26% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
The Key Takeaway
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Avarga has. Since the stock has only returned 23% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.