There Are Reasons To Feel Uneasy About Avaya Holdings' (NYSE:AVYA) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Avaya Holdings (NYSE:AVYA) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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 Avaya Holdings is:

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

0.062 = US$307m ÷ (US$6.1b - US$1.2b) (Based on the trailing twelve months to March 2021).

Thus, Avaya Holdings has an ROCE of 6.2%. Ultimately, that's a low return and it under-performs the Software industry average of 11%.

View our latest analysis for Avaya Holdings

In the above chart we have measured Avaya Holdings' 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 Avaya Holdings.

The Trend Of ROCE

On the surface, the trend of ROCE at Avaya Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.2% from 26% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Avaya Holdings has done well to pay down its current liabilities to 19% of total assets. Since the ratio used to be 74%, that's a significant reduction and it no doubt explains the drop in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Avaya Holdings' ROCE

To conclude, we've found that Avaya Holdings is reinvesting in the business, but returns have been falling. And with the stock having returned a mere 21% in the last three years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

If you want to know some of the risks facing Avaya Holdings we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.

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This article by Simply Wall St is general in nature. 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.
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