Neoenergia's (BVMF:NEOE3) Returns On Capital Are Heading Higher

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Neoenergia's (BVMF:NEOE3) returns on capital, so let's have a 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. To calculate this metric for Neoenergia, this is the formula:

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

0.13 = R$9.8b ÷ (R$92b - R$17b) (Based on the trailing twelve months to September 2022).

Thus, Neoenergia has an ROCE of 13%. By itself that's a normal return on capital and it's in line with the industry's average returns of 13%.

View our latest analysis for Neoenergia

Above you can see how the current ROCE for Neoenergia compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Neoenergia here for free.

What The Trend Of ROCE Can Tell Us

Investors would be pleased with what's happening at Neoenergia. The data shows that returns on capital have increased substantially over the last five years to 13%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 161%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a related note, the company's ratio of current liabilities to total assets has decreased to 19%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business' underlying economics, which is great to see.

In Conclusion...

All in all, it's terrific to see that Neoenergia is reaping the rewards from prior investments and is growing its capital base. Given the stock has declined 37% in the last three years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.

Like most companies, Neoenergia does come with some risks, and we've found 2 warning signs that you should be aware of.

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.

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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.