What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at AJ Lucas Group (ASX:AJL) so let's look a bit deeper.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for AJ Lucas Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.064 = AU$11m ÷ (AU$237m - AU$66m) (Based on the trailing twelve months to December 2021).
Therefore, AJ Lucas Group has an ROCE of 6.4%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 14%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for AJ Lucas Group's ROCE against it's prior returns. If you'd like to look at how AJ Lucas Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
AJ Lucas Group has broken into the black (profitability) and we're sure it's a sight for sore eyes. While the business was unprofitable in the past, it's now turned things around and is earning 6.4% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
What We Can Learn From AJ Lucas Group's ROCE
In summary, we're delighted to see that AJ Lucas Group has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Although the company may be facing some issues elsewhere since the stock has plunged 71% in the last five years. In any case, we believe the economic trends of this company are positive and looking into the stock further could prove rewarding.
AJ Lucas Group does have some risks, we noticed 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
While AJ Lucas Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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