Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 Avalon Holdings (NYSEMKT:AWX) and its trend of ROCE, we really liked what we saw.
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. Analysts use this formula to calculate it for Avalon Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.002 = US$124k ÷ (US$78m - US$17m) (Based on the trailing twelve months to December 2020).
Thus, Avalon Holdings has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 9.5%.
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 want to delve into the historical earnings, revenue and cash flow of Avalon Holdings, check out these free graphs here.
How Are Returns Trending?
Avalon Holdings has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 0.2% on its capital. In addition to that, Avalon Holdings is employing 22% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
The Bottom Line On Avalon Holdings' ROCE
In summary, it's great to see that Avalon Holdings has managed to break into profitability and is continuing to reinvest in its business. Since the stock has returned a staggering 126% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Avalon Holdings can keep these trends up, it could have a bright future ahead.
One final note, you should learn about the 4 warning signs we've spotted with Avalon Holdings (including 1 which can't be ignored) .
While Avalon Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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