Returns on Capital Paint A Bright Future For AJ Lucas Group (ASX:AJL)

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. And in light of that, the trends we're seeing at AJ Lucas Group's (ASX:AJL) look very promising so lets take a look.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for AJ Lucas Group:

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

0.45 = AU$17m ÷ (AU$104m - AU$67m) (Based on the trailing twelve months to June 2023).

So, AJ Lucas Group has an ROCE of 45%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.

Check out our latest analysis for AJ Lucas Group

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'd like to look at how AJ Lucas Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For AJ Lucas Group Tell Us?

AJ Lucas Group has not disappointed in regards to ROCE growth. The figures show that over the last five years, returns on capital have grown by 691%. 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 82% less capital than it was five years ago. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 64% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

The Key Takeaway

In the end, AJ Lucas Group has proven it's capital allocation skills are good with those higher returns from less amount of capital. And since the stock has dived 96% over the last five years, there may be other factors affecting the company's prospects. Still, it's worth doing some further research to see if the trends will continue into the future.

One final note, you should learn about the 4 warning signs we've spotted with AJ Lucas Group (including 3 which are a bit unpleasant) .

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.