AB Dynamics (LON:ABDP) Is Reinvesting At Lower Rates Of Return

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. In light of that, when we looked at AB Dynamics (LON:ABDP) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for AB Dynamics, this is the formula:

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

0.03 = UK£3.2m ÷ (UK£121m - UK£16m) (Based on the trailing twelve months to February 2021).

So, AB Dynamics has an ROCE of 3.0%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 8.3%.

View our latest analysis for AB Dynamics

In the above chart we have measured AB Dynamics' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

On the surface, the trend of ROCE at AB Dynamics doesn't inspire confidence. Around five years ago the returns on capital were 29%, but since then they've fallen to 3.0%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

The Bottom Line

We're a bit apprehensive about AB Dynamics because despite more capital being deployed in the business, returns on that capital and sales have both fallen. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 337%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a separate note, we've found 1 warning sign for AB Dynamics you'll probably want to know about.

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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