Capital Allocation Trends At Environmental Group (ASX:EGL) Aren't Ideal

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. However, after investigating Environmental Group (ASX:EGL), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Environmental Group:

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

0.081 = AU$2.3m ÷ (AU$45m - AU$16m) (Based on the trailing twelve months to June 2022).

Therefore, Environmental Group has an ROCE of 8.1%. Ultimately, that's a low return and it under-performs the Machinery industry average of 12%.

Check out the opportunities and risks within the AU Machinery industry.

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 Environmental Group's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Environmental Group's ROCE Trending?

In terms of Environmental Group's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 18% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line On Environmental Group's ROCE

While returns have fallen for Environmental Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 168% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Environmental Group does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is significant...

While Environmental Group 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.

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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.