Arad Investment & Industrial Development's (TLV:ARAD) Returns Have Hit A Wall

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Arad Investment & Industrial Development (TLV:ARAD), it didn't seem to tick all of these boxes.

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 Arad Investment & Industrial Development, this is the formula:

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

0.059 = ₪496m ÷ (₪10.0b - ₪1.5b) (Based on the trailing twelve months to December 2020).

Therefore, Arad Investment & Industrial Development has an ROCE of 5.9%. Even though it's in line with the industry average of 5.8%, it's still a low return by itself.

View our latest analysis for Arad Investment & Industrial Development

Historical performance is a great place to start when researching a stock so above you can see the gauge for Arad Investment & Industrial Development's ROCE against it's prior returns. If you're interested in investigating Arad Investment & Industrial Development's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

The returns on capital haven't changed much for Arad Investment & Industrial Development in recent years. Over the past five years, ROCE has remained relatively flat at around 5.9% and the business has deployed 70% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

On a side note, Arad Investment & Industrial Development has done well to reduce current liabilities to 15% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.

The Key Takeaway

In conclusion, Arad Investment & Industrial Development has been investing more capital into the business, but returns on that capital haven't increased. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 190% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Arad Investment & Industrial Development does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is potentially serious...

While Arad Investment & Industrial Development isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

When trading stocks or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.