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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in AJ Lucas Group's (ASX:AJL) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on AJ Lucas Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = AU$18m ÷ (AU$239m - AU$64m) (Based on the trailing twelve months to June 2020).
So, AJ Lucas Group has an ROCE of 10%. In absolute terms, that's a pretty standard return but compared to the Construction industry average it falls behind.
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 want to delve into the historical earnings, revenue and cash flow of AJ Lucas Group, check out these free graphs here.
The Trend Of ROCE
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 10% on its capital. While returns have increased, the amount of capital employed by AJ Lucas Group has remained flat over the period. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
What We Can Learn From AJ Lucas Group's ROCE
To sum it up, AJ Lucas Group is collecting higher returns from the same amount of capital, and that's impressive. And since the stock has dived 92% over the last five years, there may be other factors affecting the company's prospects. Still, it's worth doing some further research to see if the trends will continue into the future.
One final note, you should learn about the 3 warning signs we've spotted with AJ Lucas Group (including 1 which is a bit concerning) .
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
This article by Simply Wall St is general in nature. 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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