Capital Allocation Trends At Transcat (NASDAQ:TRNS) Aren't Ideal

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Having said that, from a first glance at Transcat (NASDAQ:TRNS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. To calculate this metric for Transcat, this is the formula:

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

0.097 = US$17m ÷ (US$203m - US$24m) (Based on the trailing twelve months to June 2023).

Thus, Transcat has an ROCE of 9.7%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 13%.

Check out our latest analysis for Transcat

In the above chart we have measured Transcat's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Transcat's ROCE Trend?

On the surface, the trend of ROCE at Transcat doesn't inspire confidence. Over the last five years, returns on capital have decreased to 9.7% from 12% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line On Transcat's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Transcat. And the stock has done incredibly well with a 283% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you'd like to know about the risks facing Transcat, we've discovered 2 warning signs that you should be aware of.

While Transcat isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.