Returns On Capital Are Showing Encouraging Signs At Top Ships (NASDAQ:TOPS)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. So on that note, Top Ships (NASDAQ:TOPS) looks quite promising in regards to its trends of return on capital.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on Top Ships is:

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

0.057 = US$15m ÷ (US$293m - US$25m) (Based on the trailing twelve months to December 2020).

So, Top Ships has an ROCE of 5.7%. On its own, that's a low figure but it's around the 7.1% average generated by the Oil and Gas industry.

View our latest analysis for Top Ships

In the above chart we have measured Top Ships' prior ROCE against its prior performance, but the future is arguably more important. 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

Top Ships has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 5.7% which is a sight for sore eyes. In addition to that, Top Ships is employing 367% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a related note, the company's ratio of current liabilities to total assets has decreased to 8.7%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business' underlying economics, which is great to see.

What We Can Learn From Top Ships' ROCE

Overall, Top Ships gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Although the company may be facing some issues elsewhere since the stock has plunged 100% in the last five years. Regardless, we think the underlying fundamentals warrant this stock for further investigation.

One final note, you should learn about the 4 warning signs we've spotted with Top Ships (including 2 which make us uncomfortable) .

While Top Ships 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. 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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