Aehr Test Systems (NASDAQ:AEHR) Is Very Good At Capital Allocation

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. So when we looked at the ROCE trend of Aehr Test Systems (NASDAQ:AEHR) 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. The formula for this calculation on Aehr Test Systems is:

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

0.20 = US$17m ÷ (US$105m - US$19m) (Based on the trailing twelve months to August 2023).

So, Aehr Test Systems has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

See our latest analysis for Aehr Test Systems

Above you can see how the current ROCE for Aehr Test Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Aehr Test Systems.

How Are Returns Trending?

The fact that Aehr Test Systems is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 20% on its capital. Not only that, but the company is utilizing 363% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 18%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

Our Take On Aehr Test Systems' ROCE

In summary, it's great to see that Aehr Test Systems has managed to break into profitability and is continuing to reinvest in its business. Since the stock has returned a staggering 1,738% 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 Aehr Test Systems can keep these trends up, it could have a bright future ahead.

On a final note, we found 4 warning signs for Aehr Test Systems (1 shouldn't be ignored) you should be aware of.

Aehr Test Systems is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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.