Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Allied Farmers (NZSE:ALF) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding 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. To calculate this metric for Allied Farmers, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.005 = NZ$72k ÷ (NZ$25m - NZ$10m) (Based on the trailing twelve months to December 2020).
Thus, Allied Farmers has an ROCE of 0.5%. In absolute terms, that's a low return and it also under-performs the Food industry average of 7.7%.
View our latest analysis for Allied Farmers
Historical performance is a great place to start when researching a stock so above you can see the gauge for Allied Farmers' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Allied Farmers, check out these free graphs here.
How Are Returns Trending?
In terms of Allied Farmers' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 44%, but since then they've fallen to 0.5%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a related note, Allied Farmers has decreased its current liabilities to 42% 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. Keep in mind 42% is still pretty high, so those risks are still somewhat prevalent.
Our Take On Allied Farmers' ROCE
We're a bit apprehensive about Allied Farmers because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors must expect better things on the horizon though because the stock has risen 29% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
If you'd like to know more about Allied Farmers, we've spotted 3 warning signs, and 2 of them are concerning.
While Allied Farmers 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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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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About NZSE:ALF
Flawless balance sheet with solid track record.
