Returns On Capital Signal Tricky Times Ahead For AB Dynamics (LON:ABDP)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating AB Dynamics (LON:ABDP), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for AB Dynamics:

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

0.051 = UK£5.8m ÷ (UK£138m - UK£24m) (Based on the trailing twelve months to February 2022).

Therefore, AB Dynamics has an ROCE of 5.1%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 6.7%.

See our latest analysis for AB Dynamics

Above you can see how the current ROCE for AB Dynamics compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering AB Dynamics here for free.

So How Is AB Dynamics' ROCE Trending?

On the surface, the trend of ROCE at AB Dynamics doesn't inspire confidence. Around five years ago the returns on capital were 16%, but since then they've fallen to 5.1%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for AB Dynamics. And the stock has done incredibly well with a 113% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Like most companies, AB Dynamics does come with some risks, and we've found 1 warning sign that you should be aware of.

While AB Dynamics 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.