There Are Reasons To Feel Uneasy About Irwin Naturals' (CSE:IWIN) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. In light of that, when we looked at Irwin Naturals (CSE:IWIN) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Irwin Naturals is:

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

0.12 = US$4.8m ÷ (US$64m - US$24m) (Based on the trailing twelve months to June 2022).

So, Irwin Naturals has an ROCE of 12%. In isolation, that's a pretty standard return but against the Personal Products industry average of 17%, it's not as good.

Our analysis indicates that IWIN is potentially undervalued!

Above you can see how the current ROCE for Irwin Naturals 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 Irwin Naturals here for free.

What Can We Tell From Irwin Naturals' ROCE Trend?

On the surface, the trend of ROCE at Irwin Naturals doesn't inspire confidence. Over the last two years, returns on capital have decreased to 12% from 42% two years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Irwin Naturals has done well to pay down its current liabilities to 37% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Irwin Naturals' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly then, the total return to shareholders over the last year has been flat. Therefore based on the analysis done in this article, we don't think Irwin Naturals has the makings of a multi-bagger.

One final note, you should learn about the 5 warning signs we've spotted with Irwin Naturals (including 3 which are concerning) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.