Returns On Capital Signal Tricky Times Ahead For SIMPAR (BVMF:SIMH3)

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at SIMPAR (BVMF:SIMH3) and its ROCE trend, we weren't exactly thrilled.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on SIMPAR is:

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

0.065 = R$1.9b ÷ (R$34b - R$5.3b) (Based on the trailing twelve months to June 2021).

Therefore, SIMPAR has an ROCE of 6.5%. Ultimately, that's a low return and it under-performs the Transportation industry average of 10%.

View our latest analysis for SIMPAR

Above you can see how the current ROCE for SIMPAR 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 SIMPAR here for free.

What Can We Tell From SIMPAR's ROCE Trend?

On the surface, the trend of ROCE at SIMPAR doesn't inspire confidence. Around five years ago the returns on capital were 8.7%, but since then they've fallen to 6.5%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, SIMPAR has done well to pay down its current liabilities to 16% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From SIMPAR'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 SIMPAR. And the stock has followed suit returning a meaningful 72% to shareholders over the last year. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing: We've identified 3 warning signs with SIMPAR (at least 2 which are a bit unpleasant) , and understanding them would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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