If we are to find multi-bagger potential, there are often underlying trends that can provide clues. Ideally, a business will display two trends; first growth return on capital employed (ROCE) and on the other hand, an increase amount capital employed. If you see this, it usually means it’s a company with a great business model and plenty of profitable reinvestment opportunities. That said, from the first glance at Argan tree (NYSE: AGX) We’re not jumping from our chairs on the yield trend, but taking a closer look.
Understanding Return on Capital Employed (ROCE)
Just to clarify if you’re not sure, ROCE is a measure of the pre-tax income (as a percentage) that a business earns on the capital invested in its business. To calculate this metric for Argan, here is the formula:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.071 = US $ 23 million ÷ (US $ 603 million – US $ 276 million) (Based on the last twelve months up to January 2021).
Therefore, Argan has a ROCE of 7.1%. At the end of the day, that’s a low yield and it’s lower than the construction industry average of 9.5%.
See our latest review for Argan
In the chart above, we’ve measured Argan’s past ROCE versus past performance, but arguably the future is more important. If you’d like to see what analysts are forecasting for the future, you should check out our free report for Argan.
What does the ROCE trend tell us for the argan tree?
When we looked at the ROCE trend at Argan, we didn’t gain much trust. About five years ago, returns on capital were 33%, but since then they have fallen to 7.1%. However, as both capital employed and income have increased, it appears that the company is currently continuing to grow, resulting in short-term returns. And if the capital increase generates additional returns, the company, and therefore the shareholders, will benefit in the long run.
By the way, Argan’s current liabilities are still quite high at 46% of total assets. This effectively means that suppliers (or short-term creditors) fund a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally, we would like this to decrease as that would mean less risky bonds.
The essentials on Argan’s ROCE
Even though returns on capital have declined in the short term, it looks promising to us that both income and capital employed have increased for Argan. These trends are starting to be recognized by investors as the stock has provided a 31% gain to shareholders who have held it over the past five years. Thus, this stock can still be an attractive investment opportunity, if other fundamentals prove to be solid.
On a final note, we found 2 warning signs for the argan tree that we think you should be aware of.
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