To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Speaking of which, we noticed some great changes in Avast's (LON:AVST) returns on capital, so let's have a look.
What is 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. Analysts use this formula to calculate it for Avast:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$347m ÷ (US$2.7b - US$623m) (Based on the trailing twelve months to December 2020).
Therefore, Avast has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 7.8% it's much better.
In the above chart we have measured Avast's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Avast here for free.
So How Is Avast's ROCE Trending?
Avast is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 17%. The amount of capital employed has increased too, by 172%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 23%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Avast has. And with the stock having performed exceptionally well over the last three years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Avast can keep these trends up, it could have a bright future ahead.
Avast does have some risks though, and we've spotted 4 warning signs for Avast that you might be interested in.
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.
This article by Simply Wall St is general in nature. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.