If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Engenco (ASX:EGN) and its ROCE trend, we weren't exactly thrilled.
Understanding 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. To calculate this metric for Engenco, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.032 = AU$3.4m ÷ (AU$163m - AU$55m) (Based on the trailing twelve months to December 2022).
Therefore, Engenco has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Machinery industry average of 13%.
Check out our latest analysis for Engenco
Historical performance is a great place to start when researching a stock so above you can see the gauge for Engenco's ROCE against it's prior returns. If you're interested in investigating Engenco's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Engenco Tell Us?
In terms of Engenco's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 20%, but since then they've fallen to 3.2%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Key Takeaway
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Engenco. However, total returns to shareholders over the last five years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
If you want to know some of the risks facing Engenco we've found 5 warning signs (2 are concerning!) that you should be aware of before investing here.
While Engenco isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.