If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. So on that note, Traffic Technologies (ASX:TTI) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
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. To calculate this metric for Traffic Technologies, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = AU$2.2m ÷ (AU$39m - AU$24m) (Based on the trailing twelve months to December 2021).
So, Traffic Technologies has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 4.3% generated by the Infrastructure industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Traffic Technologies' ROCE against it's prior returns. If you'd like to look at how Traffic Technologies has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Traffic Technologies Tell Us?
Traffic Technologies has not disappointed in regards to ROCE growth. We found that the returns on capital employed over the last five years have risen by 221%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. In regards to capital employed, Traffic Technologies appears to been achieving more with less, since the business is using 37% less capital to run its operation. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 60% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. And with current liabilities at those levels, that's pretty high.
The Bottom Line On Traffic Technologies' ROCE
In the end, Traffic Technologies has proven it's capital allocation skills are good with those higher returns from less amount of capital. Astute investors may have an opportunity here because the stock has declined 55% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.
If you want to know some of the risks facing Traffic Technologies we've found 4 warning signs (2 are significant!) that you should be aware of before investing here.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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