Here's What's Concerning About Evrofarma's (ATH:EVROF) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Evrofarma (ATH:EVROF) and its ROCE trend, we weren't exactly thrilled.

Understanding 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. To calculate this metric for Evrofarma, this is the formula:

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

0.0063 = €231k ÷ (€47m - €10m) (Based on the trailing twelve months to December 2021).

So, Evrofarma has an ROCE of 0.6%. Ultimately, that's a low return and it under-performs the Food industry average of 7.9%.

View our latest analysis for Evrofarma

Historical performance is a great place to start when researching a stock so above you can see the gauge for Evrofarma's ROCE against it's prior returns. If you'd like to look at how Evrofarma has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

On the surface, the trend of ROCE at Evrofarma doesn't inspire confidence. Over the last five years, returns on capital have decreased to 0.6% from 5.6% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Evrofarma has done well to pay down its current liabilities to 22% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Evrofarma's ROCE

Bringing it all together, while we're somewhat encouraged by Evrofarma's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 156% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing: We've identified 3 warning signs with Evrofarma (at least 2 which can't be ignored) , and understanding them would certainly be useful.

While Evrofarma isn't earning the highest return, check out this free list of companies that are 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.