Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, the ROCE of Alfa Laval (STO:ALFA) looks decent, right now, so lets see what the trend of returns can tell us.
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. The formula for this calculation on Alfa Laval is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = kr6.6b ÷ (kr64b - kr19b) (Based on the trailing twelve months to September 2020).
Thus, Alfa Laval has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Machinery industry average of 14%.
Above you can see how the current ROCE for Alfa Laval compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Alfa Laval.
What Does the ROCE Trend For Alfa Laval Tell Us?
The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has employed 21% more capital in the last five years, and the returns on that capital have remained stable at 15%. 15% is a pretty standard return, and it provides some comfort knowing that Alfa Laval has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
To sum it up, Alfa Laval has simply been reinvesting capital steadily, at those decent rates of return. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
Like most companies, Alfa Laval does come with some risks, and we've found 1 warning sign that 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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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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