What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating Construction Partners (NASDAQ:ROAD), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What is it?
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 Construction Partners:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$54m ÷ (US$616m - US$126m) (Based on the trailing twelve months to March 2021).
Thus, Construction Partners has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 9.8% generated by the Construction industry.
Above you can see how the current ROCE for Construction Partners compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Construction Partners.
What Does the ROCE Trend For Construction Partners Tell Us?
Unfortunately, the trend isn't great with ROCE falling from 18% four years ago, while capital employed has grown 126%. That being said, Construction Partners raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Construction Partners probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt. Additionally, we found that Construction Partners' most recent EBIT figure is around the same as the prior year, so we'd attribute the drop in ROCE mostly to the capital raise.
On a related note, Construction Partners has decreased its current liabilities to 21% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.
What We Can Learn From Construction Partners' ROCE
Bringing it all together, while we're somewhat encouraged by Construction Partners' reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 148% return in the last three years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
On a separate note, we've found 1 warning sign for Construction Partners you'll probably want to know about.
While Construction Partners 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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