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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, AVADA Group (ASX:AVD) looks quite promising in regards to its trends of return on capital.
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. To calculate this metric for AVADA Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.033 = AU$3.4m ÷ (AU$131m - AU$30m) (Based on the trailing twelve months to June 2024).
Thus, AVADA Group has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 9.9%.
View our latest analysis for AVADA Group
Historical performance is a great place to start when researching a stock so above you can see the gauge for AVADA Group's ROCE against it's prior returns. If you'd like to look at how AVADA Group has performed in the past in other metrics, you can view this free graph of AVADA Group's past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
The fact that AVADA Group is now generating some pre-tax profits from its prior investments is very encouraging. About two years ago the company was generating losses but things have turned around because it's now earning 3.3% on its capital. Not only that, but the company is utilizing 48% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
The Bottom Line
Overall, AVADA Group gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Given the stock has declined 37% in the last year, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for AVADA Group (of which 1 is significant!) that you should know about.