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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 when we looked at Afya (NASDAQ:AFYA) and its trend of ROCE, we really liked what we saw.
Understanding 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 Afya, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = R$937m ÷ (R$8.7b - R$925m) (Based on the trailing twelve months to September 2024).
Therefore, Afya has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Consumer Services industry average of 8.6% it's much better.
Above you can see how the current ROCE for Afya compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Afya for free.
What The Trend Of ROCE Can Tell Us
The trends we've noticed at Afya are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 12%. Basically the business is earning more per dollar of capital invested and in addition to that, 204% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Key Takeaway
To sum it up, Afya has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Astute investors may have an opportunity here because the stock has declined 41% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.
Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation for AFYA that compares the share price and estimated value.
While Afya 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.
