Here's What's Concerning About AdderaCare's (STO:ADDERA) Returns On Capital

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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think AdderaCare (STO:ADDERA) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for AdderaCare, this is the formula:

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

0.012 = kr2.3m ÷ (kr264m - kr71m) (Based on the trailing twelve months to December 2020).

So, AdderaCare has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 11%.

See our latest analysis for AdderaCare

In the above chart we have measured AdderaCare's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering AdderaCare here for free.

The Trend Of ROCE

When we looked at the ROCE trend at AdderaCare, we didn't gain much confidence. Around five years ago the returns on capital were 9.5%, but since then they've fallen to 1.2%. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, AdderaCare has done well to pay down its current liabilities to 27% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On AdderaCare's ROCE

Bringing it all together, while we're somewhat encouraged by AdderaCare's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 17% in the last three years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

If you'd like to know more about AdderaCare, we've spotted 5 warning signs, and 2 of them don't sit too well with us.

While AdderaCare 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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