Here's What's Concerning About Light's (BVMF:LIGT3) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Although, when we looked at Light (BVMF:LIGT3), it didn't seem to tick all of these boxes.

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 Light is:

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

0.083 = R$1.8b ÷ (R$28b - R$5.7b) (Based on the trailing twelve months to September 2022).

So, Light has an ROCE of 8.3%. Ultimately, that's a low return and it 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'd like, you can check out the forecasts from the analysts covering Light here for free.

What Does the ROCE Trend For Light Tell Us?

When we looked at the ROCE trend at Light, we didn't gain much confidence. Around five years ago the returns on capital were 13%, but since then they've fallen to 8.3%. However it looks like Light might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Light has decreased its current liabilities to 21% 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.

The Bottom Line On Light's ROCE

Bringing it all together, while we're somewhat encouraged by Light's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 68% over the last five years, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Light (including 2 which make us uncomfortable) .

While Light isn't earning the highest return, check out this free list of companies that are 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.