If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings back into the business at ever-higher rates of return. Having said that, from a first glance at Air New Zealand (NZSE:AIR) 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)
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 Air New Zealand, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.052 = NZ$309m ÷ (NZ$8.8b - NZ$2.9b) (Based on the trailing twelve months to December 2019).
So, Air New Zealand has an ROCE of 5.2%. Ultimately, that's a low return and it under-performs the Airlines industry average of 9.1%.
Above you can the how the current ROCE for Air New Zealand's compares to it's prior returns on capital, but you can only tell so much from the past. If you'd like, you can check out the forecasts from the analysts covering Air New Zealand here for free.
How Are Returns Trending?
On the surface, the trend of ROCE at Air New Zealand doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.2% from 9.0% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales recently, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
The Key Takeaway
To conclude, we've found that Air New Zealand is reinvesting in the business, but returns have been falling. Since the stock has declined 8.6% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
On a final note, we've found 4 warning signs for Air New Zealand that we think you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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Air New Zealand
Air New Zealand Limited provides passenger and cargo transportation services on scheduled airlines primarily in New Zealand, Australia, the Pacific Islands, the United Kingdom, Europe, Asia, and the United States.
Reasonable growth potential and slightly overvalued.