Has Cielo (BVMF:CIEL3) Got What It Takes To Become A Multi-Bagger?

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Cielo (BVMF:CIEL3) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Cielo is:

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

0.072 = R$1.7b ÷ (R$84b - R$60b) (Based on the trailing twelve months to March 2020).

Therefore, Cielo has an ROCE of 7.2%. Ultimately, that's a low return and it under-performs the IT industry average of 9.5%.

View our latest analysis for Cielo

Above you can see how the current ROCE for Cielo compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Cielo here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Cielo, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.2% from 22% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Cielo's current liabilities have increased over the last five years to 72% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line On Cielo's ROCE

Bringing it all together, while we're somewhat encouraged by Cielo's reinvestment in its own business, we're aware that returns are shrinking. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 81% over the last five years. Therefore based on the analysis done in this article, we don't think Cielo has the makings of a multi-bagger.

One more thing: We've identified 4 warning signs with Cielo (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.

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.

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