To find multi-bagger stock, what are the underlying trends we need to look for in a business? In a perfect world, we would like a business to invest more capital in their business, and ideally the returns from that capital increase as well. If you see this, it usually means it’s a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we considered Dynamic AB (LON: ABDP), it didn’t seem to tick all of those boxes.
Return on capital employed (ROCE): what is it?
If you’ve never worked with ROCE before, it measures the “return” (profit before tax) that a business generates on capital employed in its business. Analysts use this formula to calculate it for AB Dynamics:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.03 = £ 3.2million (£ 121million – £ 16million) (Based on the last twelve months up to February 2021).
So, AB Dynamics has a ROCE of 3.0%. In absolute terms, this is low efficiency and it is also below the auto components industry average of 8.3%.
In the graph above, we measured AB Dynamics’ past ROCE against its past performance, but the future is arguably more important. If you want, you can view analyst forecasts covering AB Dynamics here for free.
What can we say about AB Dynamics’ ROCE trend?
On the surface, the ROCE trend at AB Dynamics does not inspire confidence. About five years ago, returns on capital were 29%, but since then they have fallen to 3.0%. Considering the company is employing more capital while revenues have declined, this is a bit of a concern. This could mean that the company is losing its competitive advantage or market share, because even if more money is invested in companies, it actually produces a lower return – “less bang for the buck” per se.
What we can learn from AB Dynamics’ ROCE
We’re a little worried about AB Dynamics because despite deploying more capital in the business, both returns on that capital and sales have fallen. Yet despite these poor fundamentals, the stock has gained a whopping 445% over the past five years, so investors are looking very bullish. Either way, the current underlying trends do not bode well for long term performance, so unless they reverse we would start looking elsewhere.
If you are interested in knowing the risks that AB Dynamics faces, we have discovered 1 warning sign that you need to be aware of.
For those who like to invest in solid companies, Check it out free list of companies with strong balance sheets and high returns on equity.
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