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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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at CECO Environmental (NASDAQ:CECE), it didn't seem to tick all of these boxes.
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 CECO Environmental is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.063 = US$19m ÷ (US$414m - US$106m) (Based on the trailing twelve months to March 2021).
Therefore, CECO Environmental has an ROCE of 6.3%. On its own, that's a low figure but it's around the 7.4% average generated by the Commercial Services industry.
Above you can see how the current ROCE for CECO Environmental compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering CECO Environmental here for free.
So How Is CECO Environmental's ROCE Trending?
We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 30% in that same period. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.
What We Can Learn From CECO Environmental's ROCE
Overall, we're not ecstatic to see CECO Environmental reducing the amount of capital it employs in the business. Additionally, the stock's total return to shareholders over the last five years has been flat, which isn't too surprising. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
Like most companies, CECO Environmental does come with some risks, and we've found 2 warning signs that you should be aware of.
While CECO Environmental 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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