If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Avast (LON:AVST) so let's look a bit deeper.
What is 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 Avast:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$347m ÷ (US$2.7b - US$623m) (Based on the trailing twelve months to December 2020).
So, Avast has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 8.6% it's much better.
In the above chart we have measured Avast's 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.
So How Is Avast's ROCE Trending?
Investors would be pleased with what's happening at Avast. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 17%. Basically the business is earning more per dollar of capital invested and in addition to that, 172% 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.
On a related note, the company's ratio of current liabilities to total assets has decreased to 23%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
To sum it up, Avast 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 staggering 169% to shareholders over the last three years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
One more thing, we've spotted 3 warning signs facing Avast that you might find interesting.
While Avast 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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