Engenco's (ASX:EGN) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Engenco (ASX:EGN) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Engenco:

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

0.045 = AU$5.2m ÷ (AU$146m - AU$31m) (Based on the trailing twelve months to June 2021).

Therefore, Engenco has an ROCE of 4.5%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 9.4%.

Check out our latest analysis for Engenco

Historical performance is a great place to start when researching a stock so above you can see the gauge for Engenco's ROCE against it's prior returns. If you're interested in investigating Engenco's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Engenco's ROCE Trend?

When we looked at the ROCE trend at Engenco, we didn't gain much confidence. To be more specific, ROCE has fallen from 6.0% over the last five years. However it looks like Engenco might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Engenco has done well to pay down its current liabilities to 21% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Engenco's ROCE

To conclude, we've found that Engenco is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 346% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you'd like to know about the risks facing Engenco, we've discovered 2 warning signs that you should be aware of.

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.

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.

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