If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Alta Equipment Group (NYSE:ALTG), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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. Analysts use this formula to calculate it for Alta Equipment Group:

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

0.02 = US$9.1m ÷ (US$787m - US$325m) (Based on the trailing twelve months to September 2021).

So, Alta Equipment Group has an ROCE of 2.0%. Ultimately, that's a low return and it under-performs the Trade Distributors industry average of 12%.

View our latest analysis for Alta Equipment Group

Above you can see how the current ROCE for Alta Equipment Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Alta Equipment Group here for free.

What Does the ROCE Trend For Alta Equipment Group Tell Us?

On the surface, the trend of ROCE at Alta Equipment Group doesn't inspire confidence. Around three years ago the returns on capital were 17%, but since then they've fallen to 2.0%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Alta Equipment Group has decreased its current liabilities to 41% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Alta Equipment Group. Furthermore the stock has climbed 47% over the last year, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

One more thing, we've spotted 2 warning signs facing Alta Equipment Group that you might find interesting.

While Alta Equipment Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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.