Returns On Capital Are Showing Encouraging Signs At Traffic Technologies (ASX:TTI)

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Traffic Technologies' (ASX:TTI) returns on capital, so let's have a look.

What is Return On Capital Employed (ROCE)?

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 Traffic Technologies is:

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

0.14 = AU$2.2m ÷ (AU$39m - AU$24m) (Based on the trailing twelve months to December 2021).

Thus, Traffic Technologies has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Infrastructure industry average of 4.3% it's much better.

See our latest analysis for Traffic Technologies

Historical performance is a great place to start when researching a stock so above you can see the gauge for Traffic Technologies' ROCE against it's prior returns. If you're interested in investigating Traffic Technologies' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Traffic Technologies' ROCE Trend?

We're pretty happy with how the ROCE has been trending at Traffic Technologies. The data shows that returns on capital have increased by 221% over the trailing five years. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. In regards to capital employed, Traffic Technologies appears to been achieving more with less, since the business is using 37% less capital to run its operation. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 60% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

Our Take On Traffic Technologies' ROCE

In summary, it's great to see that Traffic Technologies has been able to turn things around and earn higher returns on lower amounts of capital. Astute investors may have an opportunity here because the stock has declined 11% in the last five years. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

On a final note, we found 3 warning signs for Traffic Technologies (1 makes us a bit uncomfortable) 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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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.