What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after investigating Air New Zealand (NZSE:AIR), we don't think it's current trends fit the mold of a multi-bagger.
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 Air New Zealand, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.052 = NZ$309m ÷ (NZ$8.8b - NZ$2.9b) (Based on the trailing twelve months to December 2019).
Therefore, Air New Zealand has an ROCE of 5.2%. Ultimately, that's a low return and it under-performs the Airlines industry average of 8.1%.
In the above chart we have a measured Air New Zealand's 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 report on analyst forecasts for the company.
What Does the ROCE Trend For Air New Zealand Tell Us?
On the surface, the trend of ROCE at Air New Zealand doesn't inspire confidence. Around five years ago the returns on capital were 9.0%, but since then they've fallen to 5.2%. However it looks like Air New Zealand might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line
To conclude, we've found that Air New Zealand is reinvesting in the business, but returns have been falling. Since the stock has declined 13% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
Air New Zealand does have some risks though, and we've spotted 3 warning signs for Air New Zealand that you might be interested in.
While Air New Zealand 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.
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.
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