To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Speaking of which, we noticed some great changes in Advanced Drainage Systems' (NYSE:WMS) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
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. To calculate this metric for Advanced Drainage Systems, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.26 = US$718m ÷ (US$3.2b - US$409m) (Based on the trailing twelve months to December 2023).
Therefore, Advanced Drainage Systems has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Building industry average of 16%.
In the above chart we have measured Advanced Drainage Systems' 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 analyst report for Advanced Drainage Systems .
What The Trend Of ROCE Can Tell Us
Advanced Drainage Systems is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 26%. The amount of capital employed has increased too, by 237%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Key Takeaway
All in all, it's terrific to see that Advanced Drainage Systems is reaping the rewards from prior investments and is growing its capital base. Since the stock has returned a staggering 595% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
One more thing to note, we've identified 2 warning signs with Advanced Drainage Systems and understanding them should be part of your investment process.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.