What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, while the ROCE is currently high for Allison Transmission Holdings (NYSE:ALSN), we aren't jumping out of our chairs because returns are decreasing.
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. The formula for this calculation on Allison Transmission Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = US$944m ÷ (US$5.1b - US$518m) (Based on the trailing twelve months to March 2024).
Thus, Allison Transmission Holdings has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.
In the above chart we have measured Allison Transmission Holdings' 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 analyst report for Allison Transmission Holdings .
How Are Returns Trending?
Over the past five years, Allison Transmission Holdings' ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So while the current operations are delivering respectable returns, unless capital employed increases we'd be hard-pressed to believe it's a multi-bagger going forward.
The Bottom Line
Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. Although the market must be expecting these trends to improve because the stock has gained 95% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you want to continue researching Allison Transmission Holdings, you might be interested to know about the 2 warning signs that our analysis has discovered.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.