There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Art's-Way Manufacturing (NASDAQ:ARTW) so let's look a bit deeper.

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 Art's-Way Manufacturing, this is the formula:

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

0.04 = US$523k ÷ (US$21m - US$7.7m) (Based on the trailing twelve months to November 2021).

So, Art's-Way Manufacturing has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Machinery industry average of 10%.

Check out our latest analysis for Art's-Way Manufacturing

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Art's-Way Manufacturing's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

It's great to see that Art's-Way Manufacturing has started to generate some pre-tax earnings from prior investments. While the business is profitable now, it used to be incurring losses on invested capital five years ago. Additionally, the business is utilizing 35% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 37% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

What We Can Learn From Art's-Way Manufacturing's ROCE

In the end, Art's-Way Manufacturing has proven it's capital allocation skills are good with those higher returns from less 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 6.7% to shareholders. So with that in mind, we think the stock deserves further research.