There Are Reasons To Feel Uneasy About Cielo's (BVMF:CIEL3) Returns On Capital

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. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Cielo (BVMF:CIEL3), 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. Analysts use this formula to calculate it for Cielo:

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

0.053 = R$1.5b ÷ (R$90b - R$61b) (Based on the trailing twelve months to September 2021).

Thus, Cielo has an ROCE of 5.3%. Ultimately, that's a low return and it under-performs the IT industry average of 11%.

See our latest analysis for Cielo

Above you can see how the current ROCE for Cielo compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Cielo here for free.

What Does the ROCE Trend For Cielo Tell Us?

In terms of Cielo's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.3% from 21% five years ago. However it looks like Cielo might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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 side note, Cielo's current liabilities have increased over the last five years to 68% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line On Cielo's ROCE

Bringing it all together, while we're somewhat encouraged by Cielo's reinvestment in its own business, we're aware that returns are shrinking. Moreover, since the stock has crumbled 88% over the last five years, it appears investors are expecting the worst. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

If you'd like to know about the risks facing Cielo, we've discovered 1 warning sign that you should be aware of.

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.