Here's What's Concerning About Locaweb Serviços de Internet's (BVMF:LWSA3) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. However, after briefly looking over the numbers, we don't think Locaweb Serviços de Internet (BVMF:LWSA3) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Locaweb Serviços de Internet:

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

0.013 = R$45m ÷ (R$4.2b - R$597m) (Based on the trailing twelve months to September 2021).

So, Locaweb Serviços de Internet has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the IT industry average of 11%.

Check out our latest analysis for Locaweb Serviços de Internet

In the above chart we have measured Locaweb Serviços de Internet'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.

So How Is Locaweb Serviços de Internet's ROCE Trending?

When we looked at the ROCE trend at Locaweb Serviços de Internet, we didn't gain much confidence. To be more specific, ROCE has fallen from 13% over the last five years. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Locaweb Serviços de Internet has decreased its current liabilities to 14% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

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 62% in the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you want to continue researching Locaweb Serviços de Internet, you might be interested to know about the 3 warning signs that our analysis has discovered.

While Locaweb Serviços de Internet may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.