Investors Met With Slowing Returns on Capital At Ecosuntek (BIT:ECK)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Ecosuntek (BIT:ECK) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is 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. Analysts use this formula to calculate it for Ecosuntek:

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

0.023 = €643k ÷ (€64m - €36m) (Based on the trailing twelve months to June 2021).

So, Ecosuntek has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Renewable Energy industry average of 4.9%.

See our latest analysis for Ecosuntek

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 Ecosuntek has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Ecosuntek Tell Us?

We're a bit concerned with the trends, because the business is applying 22% less capital than it was five years ago and returns on that capital have stayed flat. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. In addition to that, since the ROCE doesn't scream "quality" at 2.3%, it's hard to get excited about these developments.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 56% of total assets, this reported ROCE would probably be less than2.3% because total capital employed would be higher.The 2.3% ROCE could be even lower if current liabilities weren't 56% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

In Conclusion...

Overall, we're not ecstatic to see Ecosuntek reducing the amount of capital it employs in the business. Yet to long term shareholders the stock has gifted them an incredible 118% 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 4 warning signs with Ecosuntek (at least 1 which is potentially serious) , and understanding them would certainly be useful.

While Ecosuntek 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.