Returns On Capital At Eleco (LON:ELCO) Have Hit The Brakes

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So, when we ran our eye over Eleco's (LON:ELCO) trend of ROCE, we liked what we saw.

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. To calculate this metric for Eleco, this is the formula:

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

0.18 = UK£4.8m ÷ (UK£39m - UK£12m) (Based on the trailing twelve months to December 2021).

Thus, Eleco has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 7.4% it's much better.

See our latest analysis for Eleco

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

What The Trend Of ROCE Can Tell Us

The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has employed 111% more capital in the last five years, and the returns on that capital have remained stable at 18%. Since 18% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.

On a side note, Eleco has done well to reduce current liabilities to 31% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.

The Bottom Line

The main thing to remember is that Eleco has proven its ability to continually reinvest at respectable rates of return. Therefore it's no surprise that shareholders have earned a respectable 63% return if they held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.

One more thing to note, we've identified 2 warning signs with Eleco and understanding these should be part of your investment process.

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.

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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.