Capital Allocation Trends At Adacel Technologies (ASX:ADA) Aren't Ideal

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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 Adacel Technologies (ASX:ADA) 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 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. The formula for this calculation on Adacel Technologies is:

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

0.15 = AU$3.6m ÷ (AU$37m - AU$13m) (Based on the trailing twelve months to December 2020).

So, Adacel Technologies has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 14% generated by the Software industry.

View our latest analysis for Adacel Technologies

In the above chart we have measured Adacel Technologies' 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 Adacel Technologies here for free.

So How Is Adacel Technologies' ROCE Trending?

On the surface, the trend of ROCE at Adacel Technologies doesn't inspire confidence. Around five years ago the returns on capital were 54%, but since then they've fallen to 15%. However it looks like Adacel Technologies might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

The Key Takeaway

To conclude, we've found that Adacel Technologies is reinvesting in the business, but returns have been falling. Since the stock has declined 50% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Adacel Technologies has the makings of a multi-bagger.

Adacel Technologies does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit concerning...

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. 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.
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