Rio Paranapanema Energia (BVMF:GEPA3) Knows How To Allocate Capital Effectively

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So when we looked at the ROCE trend of Rio Paranapanema Energia (BVMF:GEPA3) we really liked what we saw.

Understanding 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 Rio Paranapanema Energia:

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

0.38 = R$1.2b ÷ (R$4.4b - R$1.2b) (Based on the trailing twelve months to March 2021).

Thus, Rio Paranapanema Energia has an ROCE of 38%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

Check out our latest analysis for Rio Paranapanema Energia

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Rio Paranapanema Energia has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

Rio Paranapanema Energia's ROCE growth is quite impressive. The figures show that over the last five years, ROCE has grown 138% whilst employing roughly the same amount of capital. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 27% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

What We Can Learn From Rio Paranapanema Energia's ROCE

In summary, we're delighted to see that Rio Paranapanema Energia has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Since the stock has only returned 34% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Rio Paranapanema Energia (of which 2 are a bit unpleasant!) that you should know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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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