Locaweb Serviços de Internet's (BVMF:LWSA3) Returns On Capital Not Reflecting Well On The Business

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing 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. The formula for this calculation on Locaweb Serviços de Internet is:

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

0.012 = R$46m ÷ (R$4.6b - R$798m) (Based on the trailing twelve months to March 2022).

So, Locaweb Serviços de Internet has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the IT industry average of 18%.

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 to see what analysts are forecasting going forward, you should check out our free report 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. Over the last five years, returns on capital have decreased to 1.2% from 16% 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 related note, Locaweb Serviços de Internet has decreased its current liabilities to 17% of total assets. That could partly explain why the ROCE has dropped. 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. However, despite the promising trends, the stock has fallen 70% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing, we've spotted 1 warning sign facing Locaweb Serviços de Internet that you might find interesting.

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.