Here's What's Concerning About Novozymes' (CPH:NZYM B) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So while Novozymes (CPH:NZYM B) has a high ROCE right now, lets see what we can decipher from how returns are changing.

What is Return On Capital Employed (ROCE)?

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 Novozymes is:

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

0.22 = kr.4.0b ÷ (kr.25b - kr.6.9b) (Based on the trailing twelve months to March 2022).

Therefore, Novozymes has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Chemicals industry average of 12%.

Check out our latest analysis for Novozymes

Above you can see how the current ROCE for Novozymes compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

When we looked at the ROCE trend at Novozymes, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 28%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

What We Can Learn From Novozymes' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Novozymes is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 49% 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.

On a separate note, we've found 1 warning sign for Novozymes you'll probably want to know about.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.