Zaptec's (OB:ZAP) Returns On Capital Not Reflecting Well On The Business

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 briefly looking over the numbers, we don't think Zaptec (OB:ZAP) 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)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Zaptec, this is the formula:

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

0.056 = kr23m ÷ (kr541m - kr127m) (Based on the trailing twelve months to December 2021).

Thus, Zaptec has an ROCE of 5.6%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 12%.

Check out our latest analysis for Zaptec

Above you can see how the current ROCE for Zaptec compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Zaptec.

What Can We Tell From Zaptec's ROCE Trend?

When we looked at the ROCE trend at Zaptec, we didn't gain much confidence. Around three years ago the returns on capital were 54%, but since then they've fallen to 5.6%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Zaptec has decreased its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

While returns have fallen for Zaptec in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a final note, we've found 4 warning signs for Zaptec that we think you should be aware of.

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.

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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.