Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Allied Farmers (NZSE:ALF) we aren’t jumping out of our chairs at how returns are trending, but let’s have a deeper look.
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 Allied Farmers:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.18 = NZ$3.1m ÷ (NZ$27m – NZ$10m) (Based on the trailing twelve months to December 2021).
Thus, Allied Farmers has an ROCE of 18%. In absolute terms, that’s a satisfactory return, but compared to the Food industry average of 7.0% it’s much better.
View our latest analysis for Allied Farmers
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you’d like to look at how Allied Farmers has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
On the surface, the trend of ROCE at Allied Farmers doesn’t inspire confidence. To be more specific, ROCE has fallen from 53% over the last five years. 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. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Allied Farmers has done well to pay down its current liabilities to 37% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.
The Key Takeaway
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Allied Farmers. In light of this, the stock has only gained 1.1% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
If you’d like to know about the risks facing Allied Farmers, we’ve discovered 1 warning sign that you should be aware of.
While Allied Farmers isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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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