Energy World (ASX:EWC) Could Be Struggling To Allocate Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Energy World (ASX:EWC), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Energy World, this is the formula:

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

0.026 = US$41m ÷ (US$1.7b - US$164m) (Based on the trailing twelve months to December 2021).

Therefore, Energy World has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 6.7%.

Check out our latest analysis for Energy World

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 Energy World's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Energy World Tell Us?

On the surface, the trend of ROCE at Energy World doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.6% from 5.4% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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 related note, Energy World has decreased its current liabilities to 9.7% 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.

The Bottom Line

To conclude, we've found that Energy World is reinvesting in the business, but returns have been falling. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 87% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a separate note, we've found 2 warning signs for Energy World you'll probably want to know about.

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. 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.