There Are Reasons To Feel Uneasy About Adacel Technologies' (ASX:ADA) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. Looking at Adacel Technologies (ASX:ADA), it does have a high ROCE right now, but lets see how returns are trending.

What is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Adacel Technologies:

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

0.23 = AU$6.1m ÷ (AU$40m - AU$13m) (Based on the trailing twelve months to June 2021).

Therefore, Adacel Technologies has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

View our latest analysis for Adacel Technologies

Above you can see how the current ROCE for Adacel Technologies compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Adacel Technologies' ROCE Trending?

When we looked at the ROCE trend at Adacel Technologies, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 50% where it was five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

The Key Takeaway

In summary, Adacel Technologies is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 38% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Adacel Technologies (of which 1 is concerning!) that you should know about.

Adacel Technologies is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.