Atlas Copco (STO:ATCO A) May Have Issues Allocating Its 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, while the ROCE is currently high for Atlas Copco (STO:ATCO A), we aren't jumping out of our chairs because returns are decreasing.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Atlas Copco:

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

0.28 = kr35b ÷ (kr192b - kr67b) (Based on the trailing twelve months to June 2023).

So, Atlas Copco has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.

See our latest analysis for Atlas Copco

Above you can see how the current ROCE for Atlas Copco compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Atlas Copco here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Atlas Copco, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 37%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Atlas Copco. And the stock has done incredibly well with a 160% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you want to continue researching Atlas Copco, you might be interested to know about the 1 warning sign that our analysis has discovered.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.