Here's What's Concerning About Canadian Solar's (NASDAQ:CSIQ) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Although, when we looked at Canadian Solar (NASDAQ:CSIQ), it didn't seem to tick all of these boxes.

What Is 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. The formula for this calculation on Canadian Solar is:

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

0.015 = US$115m ÷ (US$14b - US$6.0b) (Based on the trailing twelve months to September 2024).

Therefore, Canadian Solar has an ROCE of 1.5%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 8.6%.

See our latest analysis for Canadian Solar

Above you can see how the current ROCE for Canadian Solar compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Canadian Solar for free.

So How Is Canadian Solar's ROCE Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 13% five years ago, while the business's capital employed increased by 248%. Usually this isn't ideal, but given Canadian Solar conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Canadian Solar's earnings and if they change as a result from the capital raise.

On a related note, Canadian Solar has decreased its current liabilities to 44% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line On Canadian Solar's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Canadian Solar have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last five years have experienced a 45% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 4 warning signs with Canadian Solar (at least 2 which make us uncomfortable) , and understanding these would certainly be useful.

While Canadian Solar 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.