Returns On Capital Signal Tricky Times Ahead For Locaweb Serviços de Internet (BVMF:LWSA3)

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. 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.

Return On Capital Employed (ROCE): What is it?

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. 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)

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

Therefore, 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%.

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

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 13% 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 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. 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.

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. These growth trends haven't led to growth returns though, since the stock has fallen 13% over the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing, we've spotted 4 warning signs 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.

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.

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