Returns On Capital At Allied Machinery (SHSE:605060) Paint A Concerning Picture

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Allied Machinery (SHSE:605060) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Allied Machinery, this is the formula:

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

0.13 = CN¥287m ÷ (CN¥2.5b - CN¥269m) (Based on the trailing twelve months to September 2023).

Thus, Allied Machinery has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 6.0% generated by the Machinery industry.

Check out our latest analysis for Allied Machinery

Above you can see how the current ROCE for Allied Machinery compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Allied Machinery .

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Allied Machinery, we didn't gain much confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 13%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Allied Machinery has done well to pay down its current liabilities to 11% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Allied Machinery's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Allied Machinery. These trends are starting to be recognized by investors since the stock has delivered a 17% gain to shareholders who've held over the last three years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Allied Machinery does have some risks though, and we've spotted 1 warning sign for Allied Machinery that you might be interested in.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.