Avarga (SGX:U09) Shareholders Will Want The ROCE Trajectory To Continue

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Avarga (SGX:U09) and its trend of ROCE, 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. The formula for this calculation on Avarga is:

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

0.18 = S$104m ÷ (S$843m - S$272m) (Based on the trailing twelve months to June 2022).

So, Avarga has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 8.0% generated by the Forestry industry.

Our analysis indicates that U09 is potentially undervalued!

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 Avarga's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Avarga's ROCE Trending?

We like the trends that we're seeing from Avarga. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 18%. Basically the business is earning more per dollar of capital invested and in addition to that, 78% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

In Conclusion...

To sum it up, Avarga has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 32% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

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

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.