Energy World (ASX:EWC) Has Some Difficulty Using Its Capital Effectively
When researching a stock for investment, what can tell us that the company is in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Energy World (ASX:EWC), so let's see why.
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. Analysts use this formula to calculate it for Energy World:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0042 = US$6.6m ÷ (US$1.6b - US$44m) (Based on the trailing twelve months to December 2023).
Thus, Energy World has an ROCE of 0.4%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 1.8%.
Check out our latest analysis for Energy World
Historical performance is a great place to start when researching a stock so above you can see the gauge for Energy World's ROCE against it's prior returns. If you're interested in investigating Energy World's past further, check out this free graph covering Energy World's past earnings, revenue and cash flow.
The Trend Of ROCE
There is reason to be cautious about Energy World, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 2.5% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Energy World to turn into a multi-bagger.
On a side note, Energy World has done well to pay down its current liabilities to 2.8% of total assets. So we could link some of this to the decrease in ROCE. 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.
In Conclusion...
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. We expect this has contributed to the stock plummeting 79% during the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Energy World (of which 2 are a bit unpleasant!) that you should know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.
