Returns On Capital Signal Tricky Times Ahead For Adrad Holdings (ASX:AHL)

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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Adrad Holdings (ASX:AHL), it didn't seem to tick all of these boxes.

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Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for Adrad Holdings, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.057 = AU$9.6m ÷ (AU$190m - AU$23m) (Based on the trailing twelve months to December 2024).

Therefore, Adrad Holdings has an ROCE of 5.7%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 11%.

See our latest analysis for Adrad Holdings

In the above chart we have measured Adrad Holdings' 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 analyst report for Adrad Holdings .

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Adrad Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 16% over the last three years. However it looks like Adrad Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Adrad Holdings has decreased its current liabilities to 12% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Adrad Holdings' reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 20% over the last year. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Adrad Holdings does have some risks though, and we've spotted 1 warning sign for Adrad Holdings that you might be interested in.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.