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To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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.
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. 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)
0.12 = AU$21m ÷ (AU$232m - AU$56m) (Based on the trailing twelve months to December 2020).
So, AJ Lucas Group has an ROCE of 12%. By itself that's a normal return on capital and it's in line with the industry's average returns of 12%.
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 want to delve into the historical earnings, revenue and cash flow of AJ Lucas Group, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
Shareholders will be relieved that AJ Lucas Group has broken into profitability. The company now earns 12% on its capital, because five years ago it was incurring losses. 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. 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. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
Our Take On AJ Lucas Group's ROCE
To bring it all together, AJ Lucas Group has done well to increase the returns it's generating from its capital employed. Although the company may be facing some issues elsewhere since the stock has plunged 86% in the last five years. Still, it's worth doing some further research to see if the trends will continue into the future.
If you'd like to know more about AJ Lucas Group, we've spotted 4 warning signs, and 1 of them doesn't sit too well with us.
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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