If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Acadian Timber (TSE:ADN), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Acadian Timber, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = CA$22m ÷ (CA$515m - CA$15m) (Based on the trailing twelve months to March 2022).
So, Acadian Timber has an ROCE of 4.4%. In absolute terms, that's a low return and it also under-performs the Forestry industry average of 22%.
In the above chart we have measured Acadian Timber's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Acadian Timber.
How Are Returns Trending?
Things have been pretty stable at Acadian Timber, with its capital employed and returns on that capital staying somewhat the same for the last five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect Acadian Timber to be a multi-bagger going forward.
Our Take On Acadian Timber's ROCE
In summary, Acadian Timber isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Although the market must be expecting these trends to improve because the stock has gained 46% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing: We've identified 3 warning signs with Acadian Timber (at least 1 which doesn't sit too well with us) , and understanding them would certainly be useful.
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.
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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.