Environmental Group (ASX:EGL) Shareholders Will Want The ROCE Trajectory To Continue

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at Environmental Group (ASX:EGL) so let's look a bit deeper.

Return On Capital Employed (ROCE): What is it?

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. Analysts use this formula to calculate it for Environmental Group:

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

0.087 = AU$1.8m ÷ (AU$34m - AU$14m) (Based on the trailing twelve months to June 2021).

So, Environmental Group has an ROCE of 8.7%. In absolute terms, that's a low return but it's around the Machinery industry average of 9.9%.

See our latest analysis for Environmental Group

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'd like to look at how Environmental Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Environmental Group Tell Us?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. Over the last five years, returns on capital employed have risen substantially to 8.7%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 50%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a side note, Environmental Group's current liabilities are still rather high at 41% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Environmental Group has. Since the stock has returned a staggering 908% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

One more thing: We've identified 4 warning signs with Environmental Group (at least 1 which can't be ignored) , and understanding these would certainly be useful.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.