European Eltech (MCX:EELT) Might Become A Compounding Machine

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So, when we ran our eye over European Eltech's (MCX:EELT) trend of ROCE, we really liked what we saw.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for European Eltech, this is the formula:

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

0.32 = ₽382m ÷ (₽2.1b - ₽889m) (Based on the trailing twelve months to September 2020).

Thus, European Eltech has an ROCE of 32%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.

See our latest analysis for European Eltech

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

How Are Returns Trending?

It's hard not to be impressed by European Eltech's returns on capital. Over the past three years, ROCE has remained relatively flat at around 32% and the business has deployed 91% more capital into its operations. Now considering ROCE is an attractive 32%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. You'll see this when looking at well operated businesses or favorable business models.

Another thing to note, European Eltech has a high ratio of current liabilities to total assets of 43%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From European Eltech's ROCE

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. Yet over the last three years the stock has declined 43%, so the decline might provide an opening. For that reason, savvy investors might want to look further into this company in case it's a prime investment.

One more thing to note, we've identified 1 warning sign with European Eltech and understanding this should be part of your investment process.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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This article by Simply Wall St is general in nature. 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.
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