If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Tesgas (WSE:TSG) and its trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What Is It?
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. Analysts use this formula to calculate it for Tesgas:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.041 = zł3.8m ÷ (zł131m - zł37m) (Based on the trailing twelve months to September 2021).
Thus, Tesgas has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Gas Utilities industry average of 6.8%.
View our latest analysis for Tesgas
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're interested in investigating Tesgas' past further, check out this free graph of past earnings, revenue and cash flow.
So How Is Tesgas' ROCE Trending?
We're delighted to see that Tesgas is reaping rewards from its investments and has now broken into profitability. The company now earns 4.1% on its capital, because five years ago it was incurring losses. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 28% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
The Key Takeaway
To sum it up, Tesgas is collecting higher returns from the same amount of capital, and that's impressive. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 64% return over the last five years. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
Tesgas does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those shouldn't be ignored...
While Tesgas 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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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.
About WSE:TSG
Tesgas
Engages in the construction, renovation, and modernization of gas facilities in Poland.
Excellent balance sheet and good value.