Be Wary Of WestStar Industrial (ASX:WSI) And Its Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Having said that, while the ROCE is currently high for WestStar Industrial (ASX:WSI), we aren't jumping out of our chairs because returns are decreasing.

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. The formula for this calculation on WestStar Industrial is:

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

0.21 = AU$5.0m ÷ (AU$65m - AU$41m) (Based on the trailing twelve months to December 2021).

Therefore, WestStar Industrial has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 8.6% earned by companies in a similar industry.

View our latest analysis for WestStar Industrial

Historical performance is a great place to start when researching a stock so above you can see the gauge for WestStar Industrial's ROCE against it's prior returns. If you'd like to look at how WestStar Industrial 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 WestStar Industrial Tell Us?

Unfortunately, the trend isn't great with ROCE falling from 47% two years ago, while capital employed has grown 426%. Usually this isn't ideal, but given WestStar Industrial conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. WestStar Industrial probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a side note, WestStar Industrial has done well to pay down its current liabilities to 63% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for WestStar Industrial. In light of this, the stock has only gained 5.9% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

If you'd like to know about the risks facing WestStar Industrial, we've discovered 3 warning signs that you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.