Wescoal Holdings (JSE:WSL) Is Reinvesting At Lower Rates Of Return

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Wescoal Holdings (JSE:WSL), it didn't seem to tick all of these boxes.

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. The formula for this calculation on Wescoal Holdings is:

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

0.021 = R48m ÷ (R4.0b - R1.8b) (Based on the trailing twelve months to March 2021).

So, Wescoal Holdings has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 14%.

Check out our latest analysis for Wescoal Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Wescoal Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Wescoal Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.1% from 21% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Wescoal Holdings' current liabilities are still rather high at 44% of total assets. 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.

Our Take On Wescoal Holdings' ROCE

In summary, Wescoal Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last five years, the stock has given away 18% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Wescoal Holdings has the makings of a multi-bagger.

Wescoal Holdings does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those are concerning...

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.

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.