Returns On Capital At WestStar Industrial (ASX:WSI) Paint A Concerning Picture

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. So when we looked at WestStar Industrial (ASX:WSI), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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).

Thus, WestStar Industrial has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 8.8% earned by companies in a similar industry.

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

What The Trend Of ROCE Can Tell Us

Unfortunately, the trend isn't great with ROCE falling from 47% two years ago, while capital employed has grown 426%. That being said, WestStar Industrial raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with WestStar Industrial's earnings and if they change as a result from the capital raise.

On a related note, WestStar Industrial has decreased its current liabilities to 63% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 63% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

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. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

WestStar Industrial does have some risks though, and we've spotted 2 warning signs for WestStar Industrial that you might be interested in.

WestStar Industrial is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.