Be Wary Of Light (BVMF:LIGT3) And Its Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Although, when we looked at Light (BVMF:LIGT3), it didn't seem to tick all of these boxes.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Light:

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

0.091 = R$2.1b ÷ (R$27b - R$4.2b) (Based on the trailing twelve months to September 2021).

Thus, Light has an ROCE of 9.1%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 13%.

View our latest analysis for Light

In the above chart we have measured Light's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

In terms of Light's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 9.1% from 12% five years ago. 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, Light has done well to pay down its current liabilities to 15% 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.

What We Can Learn From Light's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Light 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 16% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One final note, you should learn about the 5 warning signs we've spotted with Light (including 1 which shouldn't be ignored) .

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.