Be Wary Of Omega Energia (BVMF:MEGA3) And Its Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. In light of that, when we looked at Omega Energia (BVMF:MEGA3) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Omega Energia is:

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

0.043 = R$597m ÷ (R$17b - R$3.3b) (Based on the trailing twelve months to June 2023).

So, Omega Energia has an ROCE of 4.3%. Even though it's in line with the industry average of 3.9%, it's still a low return by itself.

View our latest analysis for Omega Energia

In the above chart we have measured Omega Energia'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 Omega Energia here for free.

What The Trend Of ROCE Can Tell Us

In terms of Omega Energia's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 6.3% over the last five years. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 19%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 4.3%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On Omega Energia'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 Omega Energia. These trends are starting to be recognized by investors since the stock has delivered a 30% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

If you want to know some of the risks facing Omega Energia we've found 3 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

While Omega Energia may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.