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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Art's-Way Manufacturing's (NASDAQ:ARTW) returns on capital, so let's have a look.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Art's-Way Manufacturing, this is the formula:

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

0.062 = US$898k ÷ (US$25m - US$10m) (Based on the trailing twelve months to August 2022).

Thus, Art's-Way Manufacturing has an ROCE of 6.2%. Ultimately, that's a low return and it under-performs the Machinery industry average of 11%.

Check out our latest analysis for Art's-Way Manufacturing

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Art's-Way Manufacturing, check out these free graphs here.

What Can We Tell From Art's-Way Manufacturing's ROCE Trend?

We're delighted to see that Art's-Way Manufacturing is reaping rewards from its investments and has now broken into profitability. The company now earns 6.2% on its capital, because five years ago it was incurring losses. While returns have increased, the amount of capital employed by Art's-Way Manufacturing has remained flat over the period. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. Because in the end, a business can only get so efficient.

Another thing to note, Art's-Way Manufacturing has a high ratio of current liabilities to total assets of 41%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

To sum it up, Art's-Way Manufacturing is collecting higher returns from the same amount of capital, and that's impressive. Astute investors may have an opportunity here because the stock has declined 35% in the last five years. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

One final note, you should learn about the 3 warning signs we've spotted with Art's-Way Manufacturing (including 2 which are significant) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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