We Like These Underlying Trends At Avarga (SGX:U09)

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Avarga (SGX:U09) and its trend of ROCE, we really liked what we saw.

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 Avarga, this is the formula:

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

0.14 = S$58m ÷ (S$649m - S$243m) (Based on the trailing twelve months to June 2020).

Thus, Avarga has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Forestry industry average of 6.5% it's much better.

View our latest analysis for Avarga

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.

How Are Returns Trending?

The trends we've noticed at Avarga are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 14%. 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 125%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 37% of the business, which is more than it was five years ago. 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.

In Conclusion...

All in all, it's terrific to see that Avarga is reaping the rewards from prior investments and is growing its capital base. And a remarkable 106% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

If you want to continue researching Avarga, you might be interested to know about the 4 warning signs that our analysis has discovered.

While Avarga 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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