What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. With that in mind, we've noticed some promising trends at ADF Group (TSE:DRX) so let's look a bit deeper.
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)
0.11 = CA$21m ÷ (CA$272m - CA$89m) (Based on the trailing twelve months to January 2023).
Therefore, ADF Group has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 3.8% it's much better.
View 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'd like to look at how ADF Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
SWOT Analysis for ADF Group
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings.
- Earnings growth over the past year is below its 5-year average.
- Dividend is low compared to the top 25% of dividend payers in the Metals and Mining market.
- Current share price is above our estimate of fair value.
- DRX's financial characteristics indicate limited near-term opportunities for shareholders.
- Lack of analyst coverage makes it difficult to determine DRX's earnings prospects.
- Debt is not well covered by operating cash flow.
What Can We Tell From ADF Group's ROCE Trend?
ADF Group is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 11%. Basically the business is earning more per dollar of capital invested and in addition to that, 43% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line On ADF Group's ROCE
To sum it up, ADF Group has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has returned a solid 81% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you'd like to know about the risks facing ADF Group, we've discovered 1 warning sign that you should be aware of.
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.
