Be Wary Of Arjo (STO:ARJO B) And Its Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Arjo (STO:ARJO B) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for Arjo:

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

0.068 = kr873m ÷ (kr16b - kr3.4b) (Based on the trailing twelve months to September 2022).

Therefore, Arjo has an ROCE of 6.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.3%.

View our latest analysis for Arjo

Above you can see how the current ROCE for Arjo 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 Arjo here for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Arjo doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.8% from 15% five years ago. 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 related note, Arjo has decreased its current liabilities to 21% 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. 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 Arjo's ROCE

In summary, Arjo is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 66% over the last five years, 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.

Like most companies, Arjo does come with some risks, and we've found 3 warning signs 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. 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.