Elders (ASX:ELD) May Have Issues Allocating Its Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, while the ROCE is currently high for Elders (ASX:ELD), we aren't jumping out of our chairs because returns are decreasing.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Elders, this is the formula:

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

0.22 = AU$213m ÷ (AU$2.1b - AU$1.2b) (Based on the trailing twelve months to March 2022).

Thus, Elders has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 6.0% earned by companies in a similar industry.

See our latest analysis for Elders

Above you can see how the current ROCE for Elders compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Elders here for free.

How Are Returns Trending?

When we looked at the ROCE trend at Elders, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 38%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Elders has done well to pay down its current liabilities to 55% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 55% is still pretty high, so those risks are still somewhat prevalent.

Our Take On Elders' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Elders is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 211% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

On a final note, we found 2 warning signs for Elders (1 is potentially serious) you should be aware of.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.