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Returns On Capital Signal Tricky Times Ahead For PagSeguro Digital (NYSE:PAGS)

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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. However, after briefly looking over the numbers, we don't think PagSeguro Digital (NYSE:PAGS) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What is it?

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 PagSeguro Digital is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.16 = R$1.9b ÷ (R$27b - R$15b) (Based on the trailing twelve months to September 2021).

So, PagSeguro Digital has an ROCE of 16%. That's a relatively normal return on capital, and it's around the 14% generated by the IT industry.

See our latest analysis for PagSeguro Digital

roce
roce

In the above chart we have measured PagSeguro Digital's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering PagSeguro Digital here for free.

What Can We Tell From PagSeguro Digital's ROCE Trend?

In terms of PagSeguro Digital's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 30%, but since then they've fallen to 16%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, PagSeguro Digital has decreased its current liabilities to 55% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 55% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

While returns have fallen for PagSeguro Digital in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. In light of this, the stock has only gained 15% over the last three years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

One more thing, we've spotted 2 warning signs facing PagSeguro Digital that you might find interesting.

While PagSeguro Digital 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.