Twin Disc's (NASDAQ:TWIN) Returns On Capital Are Heading Higher

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. 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 Twin Disc (NASDAQ:TWIN) 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. The formula for this calculation on Twin Disc is:

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

0.033 = US$6.4m ÷ (US$278m - US$85m) (Based on the trailing twelve months to March 2022).

Thus, Twin Disc has an ROCE of 3.3%. Ultimately, that's a low return and it under-performs the Machinery industry average of 9.9%.

See our latest analysis for Twin Disc

In the above chart we have measured Twin Disc's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Twin Disc.

What Can We Tell From Twin Disc's ROCE Trend?

We're delighted to see that Twin Disc is reaping rewards from its investments and has now broken into profitability. The company now earns 3.3% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.

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. The current liabilities has increased to 31% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Key Takeaway

To sum it up, Twin Disc is collecting higher returns from the same amount of capital, and that's impressive. Astute investors may have an opportunity here because the stock has declined 48% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

Like most companies, Twin Disc does come with some risks, and we've found 1 warning sign that you should be aware of.

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.

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.