There are a few key trends to look for if we are to identify the next multi-bagger. Among other things, we’ll want to see two things; first, a growth return on capital employed (ROCE) and on the other hand, an expansion of the company amount capital employed. This shows us that it is a compounding machine, capable of continually reinvesting its profits into the business and generating higher returns. Speaking of which, we have noticed some big changes in Advanced drainage systems ” (NYSE: WMS) is going back on capital, so let’s take a look.
Understanding Return on Capital Employed (ROCE)
If you’ve never worked with ROCE before, it measures the “ return ” (profit before tax) that a business generates from the capital employed in its business. To calculate this metric for advanced drainage systems, here is the formula:
Return on capital employed = Earnings before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.17 = $ 349 million ÷ ($ 2.4 billion – $ 318 million) (Based on the last twelve months up to March 2021).
So, Advanced Drainage Systems has a ROCE of 17%. In absolute terms, this is a satisfactory return, but compared to the construction industry average of 13%, it is much better.
Check out our latest review for advanced drainage systems
Above you can see how the current ROCE of Advanced Drainage Systems compares to its past returns on capital, but you can’t say more about the past. If you’d like to see what analysts are forecasting for the future, you should check out our free report for Advanced Drainage Systems.
What the ROCE trend can tell us
Investors would be happy with what is happening at Advanced Drainage Systems. Data shows that returns on capital have increased dramatically over the past five years to reach 17%. Basically the business earns more per dollar of capital invested and on top of that 167% more capital is also being used now. Increasing returns from an increasing amount of capital are common among multiple baggers and that is why we are impressed.
Another thing to note, Advanced Drainage Systems reduced current liabilities to 13% of total assets during this period, effectively reducing the amount of financing from short-term suppliers or creditors. Shareholders would therefore be happy if the growth in returns came primarily from underlying business performance.
The Basics on ROCE of Advanced Drainage Systems
Overall, it is great to see that Advanced Drainage Systems is reaping the rewards of past investments and growing its capital base. And with the stock having performed exceptionally well over the past five years, these trends are being taken into account by investors. Therefore, we believe it would be worth checking out if these trends will continue.
One more thing, we spotted 2 warning signs facing advanced drainage systems that you might find interesting.
If you want to look for strong businesses with significant income, check out this free list of companies with good balance sheets and impressive returns on equity.
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