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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Webcentral's (ASX:WCG) returns on capital, so let's have a look.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Webcentral, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.035 = AU$2.8m ÷ (AU$131m - AU$51m) (Based on the trailing twelve months to December 2022).
Therefore, Webcentral has an ROCE of 3.5%. In absolute terms, that's a low return and it also under-performs the IT industry average of 17%.
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 Webcentral has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The data shows that returns on capital have increased substantially over the last five years to 3.5%. The amount of capital employed has increased too, by 1,664%. So we're very much inspired by what we're seeing at Webcentral thanks to its ability to profitably reinvest capital.
The Bottom Line
To sum it up, Webcentral has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And since the stock has fallen 47% over the last year, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Webcentral (of which 2 make us uncomfortable!) that you should know about.
While Webcentral isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.