To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, Argan (NYSE:AGX) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What Is It?
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 Argan, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$45m ÷ (US$727m - US$415m) (Based on the trailing twelve months to July 2024).
Thus, Argan has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 11% generated by the Construction industry.
Above you can see how the current ROCE for Argan compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Argan .
So How Is Argan's ROCE Trending?
Shareholders will be relieved that Argan has broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 14%, which is always encouraging. 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. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 57% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.
Our Take On Argan's ROCE
To bring it all together, Argan has done well to increase the returns it's generating from its capital employed. Since the stock has returned a staggering 209% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you want to continue researching Argan, you might be interested to know about the 1 warning sign that our analysis has discovered.
While Argan may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.
