Be Wary Of PWR Holdings (ASX:PWH) And Its Returns On Capital
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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Looking at PWR Holdings (ASX:PWH), it does have a high ROCE right now, but lets see how returns are trending.
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. To calculate this metric for PWR Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = AU$17m ÷ (AU$83m - AU$13m) (Based on the trailing twelve months to December 2020).
Therefore, PWR Holdings has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.
View our latest analysis for PWR Holdings
Above you can see how the current ROCE for PWR Holdings 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 PWR Holdings.
How Are Returns Trending?
On the surface, the trend of ROCE at PWR Holdings doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 37% where it was five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line On PWR Holdings' ROCE
Bringing it all together, while we're somewhat encouraged by PWR Holdings' reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 184% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
While PWR Holdings doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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