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. 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 at ever-higher rates of return. Although, when we looked at Train Alliance Sweden (STO:TRAIN B), it didn't seem to tick all of these boxes.
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. The formula for this calculation on Train Alliance Sweden is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.017 = kr26m ÷ (kr1.5b - kr29m) (Based on the trailing twelve months to March 2021).
Thus, Train Alliance Sweden has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Construction industry average of 14%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Train Alliance Sweden's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Train Alliance Sweden Tell Us?
On the surface, the trend of ROCE at Train Alliance Sweden doesn't inspire confidence. Around five years ago the returns on capital were 2.9%, but since then they've fallen to 1.7%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, 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.
Bringing it all together, while we're somewhat encouraged by Train Alliance Sweden's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 93% over the last year, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
One more thing: We've identified 4 warning signs with Train Alliance Sweden (at least 3 which are concerning) , and understanding these would certainly be useful.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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