Investors Shouldn't Overlook The Favourable Returns On Capital At ARB (ASX:ARB)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at ARB's (ASX:ARB) ROCE trend, we were very happy with what we saw.

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 ARB, this is the formula:

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

0.28 = AU$168m ÷ (AU$704m - AU$99m) (Based on the trailing twelve months to June 2022).

Therefore, ARB has an ROCE of 28%. In absolute terms that's a great return and it's even better than the Auto Components industry average of 11%.

See our latest analysis for ARB

In the above chart we have measured ARB'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 ARB.

So How Is ARB's ROCE Trending?

In terms of ARB's history of ROCE, it's quite impressive. Over the past five years, ROCE has remained relatively flat at around 28% and the business has deployed 121% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.

Our Take On ARB's ROCE

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. Therefore it's no surprise that shareholders have earned a respectable 84% return if they held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One more thing, we've spotted 1 warning sign facing ARB that you might find interesting.

ARB is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.