Slowing Rates Of Return At Allied Digital Services (NSE:ADSL) Leave Little Room For Excitement

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Allied Digital Services (NSE:ADSL), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Allied Digital Services:

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

0.04 = ₹203m ÷ (₹6.3b - ₹1.3b) (Based on the trailing twelve months to December 2020).

Thus, Allied Digital Services has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the IT industry average of 11%.

See our latest analysis for Allied Digital Services

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Allied Digital Services' past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 29% in that same period. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.

The Bottom Line

In summary, Allied Digital Services isn't reinvesting funds back into the business and returns aren't growing. Yet to long term shareholders the stock has gifted them an incredible 109% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a final note, we've found 4 warning signs for Allied Digital Services that we think you should be aware of.

While Allied Digital Services isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.
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