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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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, from a first glance at Cosan (NYSE:CZZ) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is 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. The formula for this calculation on Cosan is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = R$3.3b ÷ (R$84b - R$10b) (Based on the trailing twelve months to September 2020).
Thus, Cosan has an ROCE of 4.4%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 9.0%.
In the above chart we have measured Cosan's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Cosan's ROCE Trending?
The returns on capital haven't changed much for Cosan in recent years. The company has employed 66% more capital in the last five years, and the returns on that capital have remained stable at 4.4%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
The Bottom Line
As we've seen above, Cosan's returns on capital haven't increased but it is reinvesting in the business. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 495% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing: We've identified 2 warning signs with Cosan (at least 1 which can't be ignored) , and understanding them would certainly be useful.
While Cosan may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
This article by Simply Wall St is general in nature. 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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