Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Websol Energy System (NSE:WEBELSOLAR) and its trend of ROCE, we really 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 Websol Energy System, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.065 = ₹147m ÷ (₹2.9b - ₹592m) (Based on the trailing twelve months to December 2021).
Therefore, Websol Energy System has an ROCE of 6.5%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.4%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Websol Energy System 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
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The data shows that returns on capital have increased substantially over the last five years to 6.5%. Basically the business is earning more per dollar of capital invested and in addition to that, 126% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 21%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Websol Energy System has. And since the stock has fallen 24% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
Websol Energy System does have some risks, we noticed 5 warning signs (and 1 which can't be ignored) we think you should know about.
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.
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.