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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Allison Transmission Holdings' (NYSE:ALSN) 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. To calculate this metric for Allison Transmission Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$641m ÷ (US$4.5b - US$448m) (Based on the trailing twelve months to September 2021).
Therefore, Allison Transmission Holdings has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 10% it's much better.
In the above chart we have measured Allison Transmission Holdings' 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 Allison Transmission Holdings here for free.
How Are Returns Trending?
Allison Transmission Holdings has not disappointed with their ROCE growth. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 33% in that same time. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.
The Bottom Line On Allison Transmission Holdings' ROCE
In summary, we're delighted to see that Allison Transmission Holdings has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 14% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
On a final note, we've found 1 warning sign for Allison Transmission Holdings that we think you should be aware of.
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.
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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.
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