Omega Energia (BVMF:MEGA3) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Omega Energia (BVMF:MEGA3) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Omega Energia:

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

0.01 = R$128m ÷ (R$16b - R$2.9b) (Based on the trailing twelve months to September 2022).

Therefore, Omega Energia has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Renewable Energy industry average of 1.9%.

See 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 4.2% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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.

In Conclusion...

In summary, we're somewhat concerned by Omega Energia's diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 26% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Omega Energia does have some risks, we noticed 3 warning signs (and 2 which don't sit too well with us) we think you should know about.

While Omega Energia 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.