Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Lojas Quero-Quero (BVMF:LJQQ3) 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)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Lojas Quero-Quero:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = R$187m ÷ (R$2.6b - R$1.0b) (Based on the trailing twelve months to September 2021).
Therefore, Lojas Quero-Quero has an ROCE of 12%. By itself that's a normal return on capital and it's in line with the industry's average returns of 12%.
In the above chart we have measured Lojas Quero-Quero's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
In terms of Lojas Quero-Quero's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 12% from 21% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, Lojas Quero-Quero has decreased its current liabilities to 39% 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.
What We Can Learn From Lojas Quero-Quero's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Lojas Quero-Quero. However, despite the promising trends, the stock has fallen 53% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
One final note, you should learn about the 2 warning signs we've spotted with Lojas Quero-Quero (including 1 which is potentially serious) .
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.