Should You Be Impressed By ADvTECH's (JSE:ADH) Returns on Capital?

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 ADvTECH (JSE:ADH) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is 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. To calculate this metric for ADvTECH, this is the formula:

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

0.14 = R886m ÷ (R8.1b - R2.0b) (Based on the trailing twelve months to June 2020).

So, ADvTECH has an ROCE of 14%. That's a pretty standard return and it's in line with the industry average of 14%.

Check out our latest analysis for ADvTECH

Historical performance is a great place to start when researching a stock so above you can see the gauge for ADvTECH's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of ADvTECH, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at ADvTECH, we didn't gain much confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 14%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, ADvTECH has decreased its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. 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.

What We Can Learn From ADvTECH's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for ADvTECH. These growth trends haven't led to growth returns though, since the stock has fallen 29% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

ADvTECH does have some risks though, and we've spotted 2 warning signs for ADvTECH that you might be interested in.

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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