There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Aurizon Holdings’ (ASX:AZJ) returns on capital, so let’s have a look.
Understanding Return On Capital Employed (ROCE)
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 Aurizon Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.11 = AU$931m ÷ (AU$9.8b – AU$1.5b) (Based on the trailing twelve months to June 2020).
Therefore, Aurizon Holdings has an ROCE of 11%. In absolute terms, that’s a satisfactory return, but compared to the Transportation industry average of 6.3% it’s much better.
In the above chart we have measured Aurizon Holdings’ 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 report on analyst forecasts for the company.
The Trend Of ROCE
Aurizon Holdings has not disappointed in regards to ROCE growth. The figures show that over the last five years, returns on capital have grown by 21%. That’s a very favorable trend because this means that the company is earning more per dollar of capital that’s being employed. Interestingly, the business may be becoming more efficient because it’s applying 20% less capital than it was five years ago. If this trend continues, the business might be getting more efficient but it’s shrinking in terms of total assets.
What We Can Learn From Aurizon Holdings’ ROCE
From what we’ve seen above, Aurizon Holdings has managed to increase it’s returns on capital all the while reducing it’s capital base. Considering the stock has delivered 7.3% to its stockholders over the last five years, it may be fair to think that investors aren’t fully aware of the promising trends yet. Given that, we’d look further into this stock in case it has more traits that could make it multiply in the long term.
One more thing: We’ve identified 3 warning signs with Aurizon Holdings (at least 1 which is potentially serious) , and understanding them would certainly be useful.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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