Locaweb Serviços de Internet (BVMF:LWSA3) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Locaweb Serviços de Internet (BVMF:LWSA3) 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)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.027 = R$84m ÷ (R$4.4b - R$1.2b) (Based on the trailing twelve months to June 2023).

So, Locaweb Serviços de Internet has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the IT industry average of 13%.

See 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

When we looked at the ROCE trend at Locaweb Serviços de Internet, we didn't gain much confidence. Around five years ago the returns on capital were 30%, but since then they've fallen to 2.7%. 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 28% of total assets. That could partly explain why the ROCE has dropped. 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

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. Despite these promising trends, the stock has collapsed 70% over the last three years, so there could be other factors hurting the company's prospects. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

One more thing to note, we've identified 1 warning sign with Locaweb Serviços de Internet and understanding this should be part of your investment process.

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.