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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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Construction Partners (NASDAQ:ROAD), it didn't seem to tick all of these boxes.
What is 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. The formula for this calculation on Construction Partners is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.03 = US$23m ÷ (US$938m - US$163m) (Based on the trailing twelve months to March 2022).
Thus, Construction Partners has an ROCE of 3.0%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 7.5%.
In the above chart we have measured Construction Partners' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
In terms of Construction Partners' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 18% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Construction Partners has done well to pay down its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
Our Take On Construction Partners' ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Construction Partners. And the stock has followed suit returning a meaningful 69% to shareholders over the last three years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
On a final note, we found 2 warning signs for Construction Partners (1 is a bit concerning) you should be aware of.
While Construction Partners 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.