Addtech AB (publ.) (STO:ADDT B) Could Be Struggling To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. However, after investigating Addtech AB (publ.) (STO:ADDT B), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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 Addtech AB (publ.), this is the formula:

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

0.19 = kr1.8b ÷ (kr15b - kr5.3b) (Based on the trailing twelve months to September 2022).

So, Addtech AB (publ.) has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Trade Distributors industry average of 15% it's much better.

Check out the opportunities and risks within the SE Trade Distributors industry.

In the above chart we have measured Addtech AB (publ.)'s prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

When we looked at the ROCE trend at Addtech AB (publ.), we didn't gain much confidence. Over the last five years, returns on capital have decreased to 19% from 25% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Addtech AB (publ.) has decreased its current liabilities to 37% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Addtech AB (publ.)'s ROCE

While returns have fallen for Addtech AB (publ.) in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 235% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you want to continue researching Addtech AB (publ.), you might be interested to know about the 1 warning sign that our analysis has discovered.

While Addtech AB (publ.) 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. 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.