Companhia Distribuidora de Gás do Rio de Janeiro - CEG (BVMF:CEGR3) May Have Issues Allocating Its Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Having said that, while the ROCE is currently high for Companhia Distribuidora de Gás do Rio de Janeiro - CEG (BVMF:CEGR3), we aren't jumping out of our chairs because returns are decreasing.

What is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Companhia Distribuidora de Gás do Rio de Janeiro - CEG:

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

0.21 = R$582m ÷ (R$3.4b - R$643m) (Based on the trailing twelve months to March 2021).

Therefore, Companhia Distribuidora de Gás do Rio de Janeiro - CEG has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Gas Utilities industry average of 13%.

See our latest analysis for Companhia Distribuidora de Gás do Rio de Janeiro - CEG

Historical performance is a great place to start when researching a stock so above you can see the gauge for Companhia Distribuidora de Gás do Rio de Janeiro - CEG's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Companhia Distribuidora de Gás do Rio de Janeiro - CEG, check out these free graphs here.

What Can We Tell From Companhia Distribuidora de Gás do Rio de Janeiro - CEG's ROCE Trend?

In terms of Companhia Distribuidora de Gás do Rio de Janeiro - CEG's historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 27% where it was five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Companhia Distribuidora de Gás do Rio de Janeiro - CEG have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these poor fundamentals, the stock has gained a huge 195% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing to note, we've identified 1 warning sign with Companhia Distribuidora de Gás do Rio de Janeiro - CEG and understanding it should be part of your investment process.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.
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