Returns On Capital Signal Tricky Times Ahead For WestStar Industrial (ASX:WSI)
Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Having said that, while the ROCE is currently high for WestStar Industrial (ASX:WSI), we aren't jumping out of our chairs because returns are decreasing.
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. Analysts use this formula to calculate it for WestStar Industrial:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = AU$5.0m ÷ (AU$65m - AU$41m) (Based on the trailing twelve months to December 2021).
So, WestStar Industrial has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 8.8% earned by companies in a similar industry.
View our latest analysis for WestStar Industrial
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're interested in investigating WestStar Industrial's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
The trend of ROCE doesn't look fantastic because it's fallen from 47% two years ago, while the business's capital employed increased by 426%. Usually this isn't ideal, but given WestStar Industrial conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence WestStar Industrial might not have received a full period of earnings contribution from it.
On a side note, WestStar Industrial has done well to pay down its current liabilities to 63% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that WestStar Industrial is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 11% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
One more thing, we've spotted 2 warning signs facing WestStar Industrial that you might find interesting.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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.
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