Traffic Technologies (ASX:TTI) Is Experiencing Growth In Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. So on that note, Traffic Technologies (ASX:TTI) looks quite promising in regards to its trends of return on capital.

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. 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).

So, 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.

So How Is Traffic Technologies' ROCE Trending?

We're pretty happy with how the ROCE has been trending at Traffic Technologies. We found that the returns on capital employed over the last five years have risen by 221%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Speaking of capital employed, the company is actually utilizing 37% less than it was five years ago, which can be indicative of a business that's improving its efficiency. Traffic Technologies may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.

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. Essentially the business now has suppliers or short-term creditors funding about 60% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

The Key Takeaway

In the end, Traffic Technologies has proven it's capital allocation skills are good with those higher returns from less amount of capital. And since the stock has fallen 56% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.

Traffic Technologies does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those shouldn't be ignored...

While Traffic Technologies may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.