What Do The Returns On Capital At Waterco (ASX:WAT) Tell Us?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Waterco (ASX:WAT) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. To calculate this metric for Waterco, this is the formula:

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

0.043 = AU$4.9m ÷ (AU$146m - AU$34m) (Based on the trailing twelve months to June 2020).

Thus, Waterco has an ROCE of 4.3%. Ultimately, that's a low return and it under-performs the Leisure industry average of 11%.

See our latest analysis for Waterco

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

The Trend Of ROCE

On the surface, the trend of ROCE at Waterco doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.3% from 14% five years ago. 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. If these investments prove successful, this can bode very well for long term stock performance.

Our Take On Waterco's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Waterco is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 238% 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.

One more thing to note, we've identified 1 warning sign with Waterco and understanding it should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. 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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