Zotefoams (LON:ZTF) Is Reinvesting At Lower Rates Of Return

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Zotefoams (LON:ZTF), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Zotefoams is:

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

0.057 = UK£6.9m ÷ (UK£163m - UK£41m) (Based on the trailing twelve months to June 2020).

So, Zotefoams has an ROCE of 5.7%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 11%.

See our latest analysis for Zotefoams

Above you can see how the current ROCE for Zotefoams compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Zotefoams.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Zotefoams doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.7% from 9.9% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Zotefoams' current liabilities have increased over the last five years to 25% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 5.7%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

What We Can Learn From Zotefoams' ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Zotefoams have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 62% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

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

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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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