This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Avery Dennison Corporation (NYSE:AVY)’s return fundamentals and stock market performance.
Avery Dennison stock represents an ownership share in the company. As a result, your investment is being put to work to fund operations and if you want to earn an attractive return on your investment, the business needs to be making an adequate amount of money from the funds you provide. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. Therefore, looking at how efficiently Avery Dennison is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
Calculating Return On Capital Employed for AVY
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Avery Dennison is good at growing investor capital. Take a look at the formula box beneath:
ROCE Calculation for AVY
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$706m ÷ (US$5.2b – US$2.4b) = 25%
As you can see, AVY earned $25 from every $100 you invested over the previous twelve months. A good ROCE hurdle you should aim for in your investments is 15%, which is exceeded by AVY and means the company creates a good amount of earnings on capital. If this can be sustained with good reinvestment opportunities or dividend distributions your capital has the potential to compound well over time.
Does this mean I should invest?
AVY is efficient with the use of capital, but this is only the case if AVY continues to maintain the presently healthy ROCE, which will change if the company either earns less or requires more capital to create earnings. Therefore, investors need to be confident in the trend of the inputs in the formula above, so that Avery Dennison will continue the solid returns. Looking at the past 3 year period shows us that AVY boosted investor return on capital employed from 17%. With this, the current earnings of US$706m improved from US$479m and capital employed improved as well albeit by a relatively smaller amount, signifying ROCE increased as a result of a greater surge in earnings compared to the business’ use of capital.
ROCE for AVY investors has grown in the last few years and is above a benchmark that makes the company a potentially attractive stock that can achieve a solid return on investment. This makes the company an attractive place to put your money, but ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. Without considering these fundamentals, you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for AVY’s future growth? Take a look at our free research report of analyst consensus for AVY’s outlook.
- Valuation: What is AVY worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether AVY is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.