AF Gruppen (OB:AFG) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. So when we looked at AF Gruppen (OB:AFG), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for AF Gruppen, this is the formula:

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

0.26 = kr1.3b ÷ (kr14b - kr8.6b) (Based on the trailing twelve months to March 2022).

So, AF Gruppen has an ROCE of 26%. That's a fantastic return and not only that, it outpaces the average of 8.8% earned by companies in a similar industry.

Check out our latest analysis for AF Gruppen

In the above chart we have measured AF Gruppen's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering AF Gruppen here for free.

What Can We Tell From AF Gruppen's ROCE Trend?

In terms of AF Gruppen's historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 33% where it was five years ago. 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 separate but related note, it's important to know that AF Gruppen has a current liabilities to total assets ratio of 63%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On AF Gruppen's ROCE

Bringing it all together, while we're somewhat encouraged by AF Gruppen's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 54% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

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

AF Gruppen is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.