Novozymes (CPH:NZYM B) Might Be Having Difficulty Using Its Capital Effectively

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. So while Novozymes (CPH:NZYM B) has a high ROCE right now, lets see what we can decipher from how returns are changing.

Understanding 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 Novozymes is:

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

0.21 = kr.4.5b ÷ (kr.28b - kr.7.1b) (Based on the trailing twelve months to March 2023).

Thus, Novozymes has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Chemicals industry average of 12%.

View our latest analysis for Novozymes

In the above chart we have measured Novozymes' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Novozymes' ROCE Trending?

In terms of Novozymes' historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 31%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Key Takeaway

While returns have fallen for Novozymes in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends are starting to be recognized by investors since the stock has delivered a 4.5% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

Novozymes does have some risks though, and we've spotted 2 warning signs for Novozymes that you might be interested in.

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.