What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, AeroVironment (NASDAQ:AVAV) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on AeroVironment is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.075 = US$40m ÷ (US$578m - US$46m) (Based on the trailing twelve months to August 2020).
Thus, AeroVironment has an ROCE of 7.5%. Ultimately, that's a low return and it under-performs the Aerospace & Defense industry average of 9.7%.
Above you can see how the current ROCE for AeroVironment 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 AeroVironment here for free.
How Are Returns Trending?
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. Over the last five years, returns on capital employed have risen substantially to 7.5%. The amount of capital employed has increased too, by 53%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line
All in all, it's terrific to see that AeroVironment is reaping the rewards from prior investments and is growing its capital base. And a remarkable 219% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if AeroVironment can keep these trends up, it could have a bright future ahead.
One more thing to note, we've identified 1 warning sign with AeroVironment and understanding this should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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What are the risks and opportunities for AeroVironment?
Trading at 57.1% below our estimate of its fair value
Earnings are forecast to grow 147.8% per year
Significant insider selling over the past 3 months
This article by Simply Wall St is general in nature. 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.
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AeroVironment, Inc. designs, develops, produces, delivers, and supports a portfolio of robotic systems and related services for government agencies and businesses in the United States and internationally.
Adequate balance sheet with reasonable growth potential.