Elders (ASX:ELD) Might Be Having Difficulty Using Its Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after briefly looking over the numbers, we don't think Elders (ASX:ELD) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Elders is:

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

0.17 = AU$170m ÷ (AU$2.3b - AU$1.3b) (Based on the trailing twelve months to March 2023).

So, Elders has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 3.9% generated by the Food industry.

Check out 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.

SWOT Analysis for Elders

So How Is Elders' ROCE Trending?

On the surface, the trend of ROCE at Elders doesn't inspire confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 17%. 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 57% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

What We Can Learn From 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. In light of this, the stock has only gained 16% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

One more thing: We've identified 3 warning signs with Elders (at least 1 which makes us a bit uncomfortable) , and understanding them would certainly be useful.

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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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.