H2O Innovation's (CVE:HEO) Returns On Capital Are Heading Higher

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at H2O Innovation (CVE: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. Analysts use this formula to calculate it for H2O Innovation:

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

0.086 = CA$8.8m ÷ (CA$134m - CA$32m) (Based on the trailing twelve months to March 2021).

So, H2O Innovation has an ROCE of 8.6%. In absolute terms, that's a low return but it's around the Machinery industry average of 7.8%.

Check out our latest analysis for H2O Innovation

Above you can see how the current ROCE for H2O Innovation 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 H2O Innovation here for free.

How Are Returns Trending?

We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. Over the last five years, returns on capital employed have risen substantially to 8.6%. 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 239%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

One more thing to note, H2O Innovation has decreased current liabilities to 24% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

The Key Takeaway

In summary, it's great to see that H2O Innovation can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 43% return over the last five years. Therefore, we think it would be worth your time to check if these trends are going to continue.

H2O Innovation does have some risks though, and we've spotted 1 warning sign for H2O Innovation that you might be interested in.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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