If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Allied Machinery (SHSE:605060) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for Allied Machinery:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.13 = CN¥287m ÷ (CN¥2.5b - CN¥269m) (Based on the trailing twelve months to September 2023).

So, Allied Machinery has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 6.0% it's much better.

In the above chart we have measured Allied Machinery's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Allied Machinery for free.

So How Is Allied Machinery's ROCE Trending?

On the surface, the trend of ROCE at Allied Machinery doesn't inspire confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 13%. 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, Allied Machinery has done well to pay down its current liabilities to 11% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Allied Machinery is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 17% over the last three years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

If you'd like to know about the risks facing Allied Machinery, we've discovered 1 warning sign that you should be aware of.

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.