There Are Reasons To Feel Uneasy About MVV Energie's (ETR:MVV1) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at MVV Energie (ETR:MVV1) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper 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. Analysts use this formula to calculate it for MVV Energie:

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

0.033 = €233m ÷ (€23b - €16b) (Based on the trailing twelve months to June 2022).

So, MVV Energie has an ROCE of 3.3%. Ultimately, that's a low return and it under-performs the Integrated Utilities industry average of 6.1%.

Our analysis indicates that MVV1 is potentially undervalued!

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how MVV Energie has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From MVV Energie's ROCE Trend?

In terms of MVV Energie's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.3% from 7.4% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 70%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.3%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for MVV Energie. And the stock has followed suit returning a meaningful 50% to shareholders over the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you'd like to know more about MVV Energie, we've spotted 2 warning signs, and 1 of them shouldn't be ignored.

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.

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.