Arvida Group Limited (NZSE:ARV): Why Return On Capital Employed Is Important

This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Arvida Group Limited (NZSE:ARV)’s return fundamentals and stock market performance.

Buying Arvida Group makes you a partial owner of the company. As a result, your investment is being put to work to fund operations and if you want to earn an attractive return on your investment, the business needs to be making an adequate amount of money from the funds you provide. Your return is tied to ARV’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. To understand Arvida Group’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.

Arvida Group’s Return On Capital Employed

As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. We’ll look at Arvida Group’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. Take a look at the formula box beneath:

ROCE Calculation for ARV

Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)

Capital Employed = (Total Assets – Current Liabilities)

∴ ROCE = NZ\$22m ÷ (NZ\$1.1b – NZ\$122m) = 2.1%

The calculation above shows that ARV’s earnings were 2.1% of capital employed. This shows Arvida Group provides an unsatisfying capital return that is well below the 15% ROCE that is typically considered to be a strong benchmark. Nevertheless, if ARV is clever with their reinvestments or dividend payments, investors can still grow their capital although to a poor extent.

Then why have investors invested?

Arvida Group’s relatively poor ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Arvida Group is in an adverse position, but this can change if these factors improve. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Three years ago, ARV’s ROCE was 1.1%, which means the company’s capital returns have improved. With this, the current earnings of NZ\$22m improved from NZ\$4m and capital employed improved as well albeit by a relatively smaller amount, signifying ROCE increased as a result of a greater surge in earnings compared to the business’ use of capital.

Next Steps

ROCE for ARV investors is below the desired level at the moment, however, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and management ability to determine if an opportunity exists that isn’t made apparent by looking at past data. Arvida Group’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.

1. Future Outlook: What are well-informed industry analysts predicting for ARV’s future growth? Take a look at our free research report of analyst consensus for ARV’s outlook.
2. Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Arvida Group’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.