Avarga (SGX:U09) Is Very Good At Capital Allocation

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. So when we looked at the ROCE trend of Avarga (SGX:U09) we really liked what we saw.

Understanding 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. To calculate this metric for Avarga, this is the formula:

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

0.24 = S$109m ÷ (S$651m - S$197m) (Based on the trailing twelve months to December 2020).

Therefore, Avarga has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Forestry industry average of 7.5%.

Check out our latest analysis for Avarga

Historical performance is a great place to start when researching a stock so above you can see the gauge for Avarga's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Avarga, check out these free graphs here.

How Are Returns Trending?

Avarga is displaying some positive trends. Over the last five years, returns on capital employed have risen substantially to 24%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 146%. So we're very much inspired by what we're seeing at Avarga thanks to its ability to profitably reinvest capital.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 30% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Avarga has. Since the stock has returned a staggering 159% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Avarga can keep these trends up, it could have a bright future ahead.

On a separate note, we've found 1 warning sign for Avarga you'll probably want to know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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