H2O Innovation (TSE:HEO) Shareholders Will Want The ROCE Trajectory To Continue

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at H2O Innovation (TSE:HEO) and its trend of ROCE, we really liked what we saw.

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 H2O Innovation is:

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

0.042 = CA$7.3m ÷ (CA$214m - CA$38m) (Based on the trailing twelve months to September 2022).

So, H2O Innovation has an ROCE of 4.2%. In absolute terms, that's a low return but it's around the Machinery industry average of 5.1%.

Check out our latest analysis for H2O Innovation

In the above chart we have measured H2O Innovation'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 H2O Innovation here for free.

What Can We Tell From H2O Innovation's ROCE Trend?

H2O Innovation has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 4.2% on its capital. Not only that, but the company is utilizing 252% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 18%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

The Bottom Line On H2O Innovation's ROCE

In summary, it's great to see that H2O Innovation has managed to break into profitability and is continuing to reinvest in its business. And a remarkable 116% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

One final note, you should learn about the 2 warning signs we've spotted with H2O Innovation (including 1 which is a bit concerning) .

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.