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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in AJ Lucas Group's (ASX:AJL) returns on capital, so let's have a look.
What Is 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. To calculate this metric for AJ Lucas Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.45 = AU$17m ÷ (AU$104m - AU$67m) (Based on the trailing twelve months to June 2023).
Therefore, AJ Lucas Group has an ROCE of 45%. In absolute terms that's a great return and it's even better than the Construction industry average of 13%.
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.
So How Is AJ Lucas Group's ROCE Trending?
We're pretty happy with how the ROCE has been trending at AJ Lucas Group. The data shows that returns on capital have increased by 691% over the trailing five years. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Interestingly, the business may be becoming more efficient because it's applying 82% less capital than it was five years ago. AJ Lucas Group may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 64% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
The Bottom Line On AJ Lucas Group's ROCE
In summary, it's great to see that AJ Lucas Group has been able to turn things around and earn higher returns on lower amounts of capital. Although the company may be facing some issues elsewhere since the stock has plunged 96% in the last five years. 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 5 warning signs we've spotted with AJ Lucas Group (including 3 which are a bit unpleasant) .
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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.