Eltek (NASDAQ:ELTK) Is Looking To Continue Growing Its Returns On Capital

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. 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 looked at Eltek (NASDAQ:ELTK) and its trend of ROCE, we really liked what we saw.

Understanding 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. The formula for this calculation on Eltek is:

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

0.057 = US$1.8m ÷ (US$40m - US$9.4m) (Based on the trailing twelve months to June 2022).

Thus, Eltek has an ROCE of 5.7%. Ultimately, that's a low return and it under-performs the Electronic industry average of 12%.

See our latest analysis for Eltek

Historical performance is a great place to start when researching a stock so above you can see the gauge for Eltek's ROCE against it's prior returns. If you'd like to look at how Eltek has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Eltek's ROCE Trend?

We're delighted to see that Eltek is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 5.7% on its capital. Not only that, but the company is utilizing 330% more capital than before, but that's to be expected from a company 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.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 23%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

What We Can Learn From Eltek's ROCE

Overall, Eltek gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has only returned 26% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So with that in mind, we think the stock deserves further research.

Eltek does have some risks, we noticed 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

While Eltek 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.