Returns On Capital - An Important Metric For Engenco (ASX:EGN)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Engenco's (ASX:EGN) returns on capital, so let's have a look.

What is 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. The formula for this calculation on Engenco is:

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

0.11 = AU$12m ÷ (AU$144m - AU$32m) (Based on the trailing twelve months to June 2020).

Thus, Engenco has an ROCE of 11%. By itself that's a normal return on capital and it's in line with the industry's average returns of 11%.

See 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're interested in investigating Engenco's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

Engenco has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 11% on its capital. And unsurprisingly, like most companies trying to break into the black, Engenco is utilizing 140% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 22%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

The Key Takeaway

Long story short, we're delighted to see that Engenco's reinvestment activities have paid off and the company is now profitable. And a remarkable 796% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if Engenco can keep these trends up, it could have a bright future ahead.

One more thing, we've spotted 1 warning sign facing Engenco that you might find interesting.

While Engenco 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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