What trends should we look for if we are to identify stocks that can multiply in value over the long term? A common approach is to try to find a business with Return on capital employed (ROCE) which increases, in connection with growth amount capital employed. Put simply, these types of businesses are dialing machines, which means they continually reinvest their profits at ever higher rates of return. Although, when we considered Wescoal Holdings (JSE: WSL) it didn’t seem to tick all of those boxes.
Return on capital employed (ROCE): what is it?
For those who don’t know what ROCE is, it measures the amount of pre-tax profit a business can generate from the capital employed in its business. The formula for this calculation on Wescoal Holdings is:
Return on capital employed = Profit before interest and taxes (EBIT) Ã· (Total assets – Current liabilities)
0.021 = R48m (R4.0b – R1.8b) (Based on the last twelve months up to March 2021).
So, Wescoal Holdings has a ROCE of 2.1%. In absolute terms, this is a low return and it is also below the industry average for commercial distributors of 14%.
Check out our latest analysis for Wescoal Holdings
Although the past is not representative of the future, it can be useful to know the historical performance of a company, which is why we have this graph above. If you want to look at Wescoal Holdings’ performance in the past in other metrics, you can check out this free graph of past income, income and cash flow.
What is the trend for returns?
When we looked at the trend in ROCE at Wescoal Holdings, we didn’t gain much confidence. Over the past five years, return on capital has declined to 2.1% from 21% five years ago. Meanwhile, the company is using more capital, but it hasn’t changed much in terms of sales over the past 12 months, so it might reflect longer-term investments. It’s worth keeping an eye on the company’s profits from now on to see if those investments end up contributing to the bottom line.
On the other hand, Wescoal Holdings’ current liabilities are still quite high at 44% of total assets. What this actually means is that suppliers (or short-term creditors) fund a large part of the business, so just be aware that this can introduce some elements of risk. Ideally, we would like this to decrease as that would mean less risky bonds.
Our opinion on the ROCE of Wescoal Holdings
In summary, Wescoal Holdings is reinvesting funds in the business for growth, but sadly it looks like sales haven’t grown much yet. And over the past five years, the stock has lost 18%, so the market doesn’t seem overly bullish that these trends will strengthen anytime soon. Therefore, based on the analysis in this article, we don’t think Wescoal Holdings has the makings of a multi-bagger.
Wescoal Holdings does carry certain risks however, we have found 3 warning signs in our investment analysis, and 2 of them concern …
If you want to look for solid businesses with great income, check out this free list of companies with good balance sheets and impressive returns on equity.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.