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. 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 Aviat Networks (NASDAQ:AVNW) and its trend of ROCE, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
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 Aviat Networks:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$24m ÷ (US$298m - US$96m) (Based on the trailing twelve months to July 2021).
Thus, Aviat Networks has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Communications industry average of 6.8% it's much better.
Above you can see how the current ROCE for Aviat Networks 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 Aviat Networks.
What Can We Tell From Aviat Networks' ROCE Trend?
We're delighted to see that Aviat Networks is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 12% on its capital. And unsurprisingly, like most companies trying to break into the black, Aviat Networks is utilizing 204% more capital than it was five years ago. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
One more thing to note, Aviat Networks has decreased current liabilities to 32% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
The Key Takeaway
In summary, it's great to see that Aviat Networks has managed to break into profitability and is continuing to reinvest in its business. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. 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.
One final note, you should learn about the 4 warning signs we've spotted with Aviat Networks (including 2 which don't sit too well with us) .
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.
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.
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