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

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing 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.

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 Locaweb Serviços de Internet, this is the formula:

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

0.021 = R$76m ÷ (R$4.7b - R$1.1b) (Based on the trailing twelve months to March 2023).

So, Locaweb Serviços de Internet has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the IT industry average of 13%.

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'd like, you can check out the forecasts from the analysts covering Locaweb Serviços de Internet here for free.

The Trend Of ROCE

On the surface, the trend of ROCE at Locaweb Serviços de Internet doesn't inspire confidence. To be more specific, ROCE has fallen from 29% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. 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 23% 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. 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

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Locaweb Serviços de Internet. These growth trends haven't led to growth returns though, since the stock has fallen 35% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you'd like to know about the risks facing Locaweb Serviços de Internet, we've discovered 2 warning signs that you should be aware of.

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.