Be Wary Of Engenco (ASX:EGN) And Its Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Engenco (ASX:EGN), it didn't seem to tick all of these boxes.

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 Engenco, this is the formula:

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

0.053 = AU$6.0m ÷ (AU$175m - AU$62m) (Based on the trailing twelve months to June 2023).

So, Engenco has an ROCE of 5.3%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 9.7%.

Check out our latest analysis for Engenco

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 want to delve into the historical earnings, revenue and cash flow of Engenco, check out these free graphs here.

What Does the ROCE Trend For Engenco Tell Us?

When we looked at the ROCE trend at Engenco, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Engenco's current liabilities have increased over the last five years to 35% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 5.3%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

Our Take On Engenco's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Engenco is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 41% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a separate note, we've found 2 warning signs for Engenco you'll probably want to know about.

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.