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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. So on that note, KHD Humboldt Wedag International (ETR:KWG) looks quite promising in regards to its trends of return on capital.
What Is 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. To calculate this metric for KHD Humboldt Wedag International, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.028 = €3.5m ÷ (€237m - €115m) (Based on the trailing twelve months to December 2023).
Therefore, KHD Humboldt Wedag International has an ROCE of 2.8%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 11%.
Check out our latest analysis for KHD Humboldt Wedag International
Historical performance is a great place to start when researching a stock so above you can see the gauge for KHD Humboldt Wedag International's ROCE against it's prior returns. If you'd like to look at how KHD Humboldt Wedag International has performed in the past in other metrics, you can view this free graph of KHD Humboldt Wedag International's past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
Like most people, we're pleased that KHD Humboldt Wedag International is now generating some pretax earnings. While the business is profitable now, it used to be incurring losses on invested capital five years ago. Additionally, the business is utilizing 29% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. KHD Humboldt Wedag International could be selling under-performing assets since the ROCE is improving.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 48% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.