Be Wary Of Locaweb Serviços de Internet (BVMF:LWSA3) And Its Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. In light of that, when we looked at Locaweb Serviços de Internet (BVMF:LWSA3) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Locaweb Serviços de Internet, this is the formula:

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

0.015 = R$53m ÷ (R$4.6b - R$987m) (Based on the trailing twelve months to September 2022).

Therefore, Locaweb Serviços de Internet has an ROCE of 1.5%. In absolute terms, that's a low return and it also under-performs the IT industry average of 16%.

View our latest analysis for Locaweb Serviços de Internet

Above you can see how the current ROCE for Locaweb Serviços de Internet 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 Locaweb Serviços de Internet here for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Locaweb Serviços de Internet doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.5% from 24% 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 side note, Locaweb Serviços de Internet has done well to pay down its current liabilities to 21% 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. 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 On Locaweb Serviços de Internet's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Locaweb Serviços de Internet is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 34% in the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

On a final note, we found 2 warning signs for Locaweb Serviços de Internet (1 is a bit unpleasant) you should be aware of.

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.