Piovan (BIT:PVN) Could Be Struggling To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. So while Piovan (BIT:PVN) has a high ROCE right now, lets see what we can decipher from how returns are changing.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Piovan is:

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

0.26 = €37m ÷ (€288m - €146m) (Based on the trailing twelve months to September 2021).

Thus, Piovan has an ROCE of 26%. That's a fantastic return and not only that, it outpaces the average of 6.1% earned by companies in a similar industry.

View our latest analysis for Piovan

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're interested in investigating Piovan's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Piovan, we didn't gain much confidence. Historically returns on capital were even higher at 44%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Piovan's current liabilities are still rather high at 51% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Piovan's ROCE

While returns have fallen for Piovan in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 48% to shareholders over the last three years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

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

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.