Returns On Capital Signal Tricky Times Ahead For Vincenzo Zucchi (BIT:ZUC)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Vincenzo Zucchi (BIT:ZUC), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Vincenzo Zucchi is:

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

0.06 = €5.3m ÷ (€126m - €37m) (Based on the trailing twelve months to December 2020).

Thus, Vincenzo Zucchi has an ROCE of 6.0%. Even though it's in line with the industry average of 6.1%, it's still a low return by itself.

Check out our latest analysis for Vincenzo Zucchi

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

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Vincenzo Zucchi doesn't inspire confidence. Around one year ago the returns on capital were 38%, but since then they've fallen to 6.0%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Vincenzo Zucchi has done well to pay down its current liabilities to 30% of total assets. Since the ratio used to be 90%, that's a significant reduction and it no doubt explains the drop in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Vincenzo Zucchi's ROCE

Bringing it all together, while we're somewhat encouraged by Vincenzo Zucchi's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 49% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Vincenzo Zucchi does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.

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