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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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, KHD Humboldt Wedag International (ETR:KWG) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What Is It?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on KHD Humboldt Wedag International is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.032 = €4.6m ÷ (€254m - €107m) (Based on the trailing twelve months to December 2022).
Therefore, KHD Humboldt Wedag International has an ROCE of 3.2%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 10.0%.
See our latest analysis for KHD Humboldt Wedag International
Historical performance is a great place to start when researching a stock so above you can see the gauge for KHD Humboldt Wedag International's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of KHD Humboldt Wedag International, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
We're delighted to see that KHD Humboldt Wedag International is reaping rewards from its investments and has now broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 3.2% on its capital. While returns have increased, the amount of capital employed by KHD Humboldt Wedag International has remained flat over the period. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
On a separate but related note, it's important to know that KHD Humboldt Wedag International has a current liabilities to total assets ratio of 42%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.