Locaweb Serviços de Internet (BVMF:LWSA3) Will Want To Turn Around Its Return Trends

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Locaweb Serviços de Internet (BVMF:LWSA3), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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)

0.016 = R$59m ÷ (R$4.7b - R$1.1b) (Based on the trailing twelve months to December 2022).

Therefore, Locaweb Serviços de Internet has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the IT industry average of 13%.

Check out 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.

SWOT Analysis for Locaweb Serviços de Internet

What Can We Tell From Locaweb Serviços de Internet's ROCE Trend?

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. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

While returns have fallen for Locaweb Serviços de Internet in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. In light of this, the stock has only gained 5.5% over the last three years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

One more thing to note, we've identified 2 warning signs with Locaweb Serviços de Internet and understanding them should be part of your investment process.

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.