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What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So on that note, Luna Innovations (NASDAQ:LUNA) looks quite promising in regards to its trends of return on capital.
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. Analysts use this formula to calculate it for Luna Innovations:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.095 = US$7.7m ÷ (US$96m - US$15m) (Based on the trailing twelve months to September 2020).
Thus, Luna Innovations has an ROCE of 9.5%. On its own, that's a low figure but it's around the 11% average generated by the Electronic industry.
Above you can see how the current ROCE for Luna Innovations compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Luna Innovations.
What Can We Tell From Luna Innovations' ROCE Trend?
We're delighted to see that Luna Innovations is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 9.5% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Luna Innovations is utilizing 137% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
One more thing to note, Luna Innovations has decreased current liabilities to 15% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
The Key Takeaway
In summary, it's great to see that Luna Innovations has managed to break into profitability and is continuing to reinvest in its business. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Luna Innovations can keep these trends up, it could have a bright future ahead.
On a final note, we've found 2 warning signs for Luna Innovations that we think you should be aware of.
While Luna Innovations isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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