Be Wary Of Erbud (WSE:ERB) And Its Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after investigating Erbud (WSE:ERB), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Erbud is:

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

0.088 = zł80m ÷ (zł1.9b - zł971m) (Based on the trailing twelve months to September 2021).

So, Erbud has an ROCE of 8.8%. Ultimately, that's a low return and it under-performs the Construction industry average of 11%.

View our latest analysis for Erbud

Historical performance is a great place to start when researching a stock so above you can see the gauge for Erbud's ROCE against it's prior returns. If you're interested in investigating Erbud's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Erbud's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 12%, but since then they've fallen to 8.8%. 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 related note, Erbud has decreased its current liabilities to 52% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Erbud. In light of this, the stock has only gained 34% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

Erbud does have some risks though, and we've spotted 2 warning signs for Erbud that you might be interested in.

While Erbud 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.