ML System's (WSE:MLS) Returns On Capital Not Reflecting Well On The Business

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think ML System (WSE:MLS) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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. Analysts use this formula to calculate it for ML System:

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

0.041 = zł9.9m ÷ (zł306m - zł61m) (Based on the trailing twelve months to September 2020).

Thus, ML System has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 6.2%.

Check out our latest analysis for ML System

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 ML System 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 ML System Tell Us?

We weren't thrilled with the trend because ML System's ROCE has reduced by 44% over the last three years, while the business employed 183% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence ML System might not have received a full period of earnings contribution from it.

On a side note, ML System has done well to pay down its current liabilities to 20% of total assets. So we could link some of this to the decrease 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. 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

In summary, despite lower returns in the short term, we're encouraged to see that ML System is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 292% to shareholders in the last year. So should these growth trends continue, we'd be optimistic on the stock going forward.

ML System does have some risks, we noticed 4 warning signs (and 1 which is significant) we think you should know about.

While ML System may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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