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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Looking at Advanced Enzyme Technologies (NSE:ADVENZYMES), it does have a high ROCE right now, but lets see how returns are trending.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Advanced Enzyme Technologies:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = ₹2.0b ÷ (₹11b - ₹549m) (Based on the trailing twelve months to December 2020).
Therefore, Advanced Enzyme Technologies has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.
In the above chart we have measured Advanced Enzyme Technologies' 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 Advanced Enzyme Technologies' ROCE Trending?
In terms of Advanced Enzyme Technologies' historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 36%, but they have dropped over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a side note, Advanced Enzyme Technologies has done well to pay down its current liabilities to 5.2% of total assets. That could partly explain why the ROCE has dropped. 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 Advanced Enzyme Technologies' ROCE
To conclude, we've found that Advanced Enzyme Technologies is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 62% over the last three years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
On a separate note, we've found 1 warning sign for Advanced Enzyme Technologies you'll probably want to know about.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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