If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Austin Engineering (ASX:ANG) and its trend of ROCE, we really liked what we saw.
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 Austin Engineering, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = AU$12m ÷ (AU$180m - AU$67m) (Based on the trailing twelve months to June 2020).
So, Austin Engineering has an ROCE of 11%. That's a pretty standard return and it's in line with the industry average of 11%.
In the above chart we have measured Austin Engineering's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Austin Engineering here for free.
The Trend Of ROCE
We're delighted to see that Austin Engineering is reaping rewards from its investments and has now broken into profitability. The company was generating losses five years ago, but now it's turned around, earning 11% which is no doubt a relief for some early shareholders. In regards to capital employed, Austin Engineering is using 36% less capital than it was five years ago, which on the surface, can indicate that the business has become more efficient at generating these returns. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.
What We Can Learn From Austin Engineering's ROCE
In the end, Austin Engineering has proven it's capital allocation skills are good with those higher returns from less amount of capital. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. So researching this company further and determining whether or not these trends will continue seems justified.
If you'd like to know about the risks facing Austin Engineering, we've discovered 2 warning signs that you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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Austin Engineering Limited, together with its subsidiaries, engages in the manufacture, repair, overhaul, and supply of mining attachment products, and other associated products and services for the industrial and resources-related business sectors.
Flawless balance sheet with solid track record.