If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, Art's-Way Manufacturing (NASDAQ:ARTW) looks quite promising in regards to its trends of return on capital.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.083 = US$1.3m ÷ (US$26m - US$10m) (Based on the trailing twelve months to August 2023).

Thus, Art's-Way Manufacturing has an ROCE of 8.3%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 12%.

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.

The Trend Of ROCE

Shareholders will be relieved that Art's-Way Manufacturing has broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 8.3% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. 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.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 40% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

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. Since the total return from the stock has been almost flat over the last five years, there might be an opportunity here if the valuation looks good. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

Art's-Way Manufacturing does have some risks, we noticed 3 warning signs (and 1 which is a bit concerning) we think you should know about.

While Art's-Way Manufacturing isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.