What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Speaking of which, we noticed some great changes in Delta Apparel's (NYSEMKT:DLA) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Delta Apparel is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = US$18m ÷ (US$420m - US$96m) (Based on the trailing twelve months to October 2020).
So, Delta Apparel has an ROCE of 5.5%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 14%.
Above you can see how the current ROCE for Delta Apparel 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 Delta Apparel here for free.
What The Trend Of ROCE Can Tell Us
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The data shows that returns on capital have increased substantially over the last five years to 5.5%. The amount of capital employed has increased too, by 34%. So we're very much inspired by what we're seeing at Delta Apparel thanks to its ability to profitably reinvest capital.
What We Can Learn From Delta Apparel's ROCE
To sum it up, Delta Apparel has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has returned a solid 59% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
Delta Apparel does have some risks, we noticed 3 warning signs (and 2 which can't be ignored) we think you should know about.
While Delta Apparel 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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