If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at ADF Group (TSE:DRX) and its trend of ROCE, we really liked what we saw.
Understanding 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. To calculate this metric for ADF Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.075 = CA$11m ÷ (CA$201m - CA$52m) (Based on the trailing twelve months to January 2022).
Thus, ADF Group has an ROCE of 7.5%. On its own that's a low return, but compared to the average of 2.4% generated by the Metals and Mining industry, it's much better.
See our latest analysis for ADF Group
Historical performance is a great place to start when researching a stock so above you can see the gauge for ADF Group's ROCE against it's prior returns. If you're interested in investigating ADF Group's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
ADF Group's ROCE growth is quite impressive. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 150% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
The Bottom Line On ADF Group's ROCE
In summary, we're delighted to see that ADF Group has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Given the stock has declined 36% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.
ADF Group does have some risks, we noticed 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.
While ADF Group 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.
About TSX:DRX
ADF Group
Engages in the design and engineering of connections including industrial coatings in Canada and the United States.
Outstanding track record with flawless balance sheet.
