Will the Promising Trends At H2O Innovation (CVE:HEO) Continue?

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at H2O Innovation (CVE:HEO) so let's look a bit deeper.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from 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)

0.07 = CA$6.6m ÷ (CA$122m - CA$28m) (Based on the trailing twelve months to September 2020).

Therefore, H2O Innovation has an ROCE of 7.0%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 11%.

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?

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The data shows that returns on capital have increased substantially over the last five years to 7.0%. 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 237%. 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 23% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.

The Bottom Line

To sum it up, H2O Innovation has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 90% return over the last five years. Therefore, we think it would be worth your time to check if these trends are going to continue.

Like most companies, H2O Innovation does come with some risks, and we've found 1 warning sign that you should be aware of.

While H2O Innovation 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. 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.
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