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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Aviat Networks (NASDAQ:AVNW) and its trend of ROCE, we really liked what we saw.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Aviat Networks, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$24m ÷ (US$298m - US$96m) (Based on the trailing twelve months to July 2021).
Thus, Aviat Networks has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Communications industry average of 7.0% it's much better.
In the above chart we have measured Aviat Networks' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Aviat Networks.
The Trend Of ROCE
Aviat Networks has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 12% which is a sight for sore eyes. In addition to that, Aviat Networks is employing 204% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
On a related note, the company's ratio of current liabilities to total assets has decreased to 32%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.
The Bottom Line
Overall, Aviat Networks gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has returned a staggering 660% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Aviat Networks (of which 2 are significant!) that you should know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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