Returns On Capital Signal Tricky Times Ahead For Essity (STO:ESSITY B)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Essity (STO:ESSITY B) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Essity:

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

0.09 = kr12b ÷ (kr184b - kr53b) (Based on the trailing twelve months to March 2022).

So, Essity has an ROCE of 9.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.8%.

View our latest analysis for Essity

Above you can see how the current ROCE for Essity compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Essity doesn't inspire confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 9.0%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

What We Can Learn From Essity's ROCE

While returns have fallen for Essity in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, total returns to shareholders over the last three years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing to note, we've identified 3 warning signs with Essity and understanding these should be part of your investment process.

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.