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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. However, after briefly looking over the numbers, we don't think TheWorks.co.uk (LON:WRKS) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on TheWorks.co.uk is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = UK£15m ÷ (UK£171m - UK£63m) (Based on the trailing twelve months to May 2022).
Thus, TheWorks.co.uk has an ROCE of 14%. By itself that's a normal return on capital and it's in line with the industry's average returns of 14%.
In the above chart we have measured TheWorks.co.uk's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for TheWorks.co.uk.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at TheWorks.co.uk doesn't inspire confidence. To be more specific, ROCE has fallen from 18% over the last five years. 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.
On a side note, TheWorks.co.uk has done well to pay down its current liabilities to 37% 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.
What We Can Learn From TheWorks.co.uk's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for TheWorks.co.uk. These growth trends haven't led to growth returns though, since the stock has fallen 53% over the last three years. 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 TheWorks.co.uk we've found 4 warning signs (2 are potentially serious!) that you should be aware of before investing here.
While TheWorks.co.uk isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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