Yahoo Finance We Like These Underlying Trends At H2O Innovation (CVE:HEO)
If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, H2O Innovation (CVE:HEO) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for H2O Innovation, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.084 = CA$7.8m ÷ (CA$119m - CA$26m) (Based on the trailing twelve months to December 2020).
Therefore, H2O Innovation has an ROCE of 8.4%. Ultimately, that's a low return and it under-performs the Machinery industry average of 11%.
See our latest analysis for H2O Innovation
Above you can see how the current ROCE for H2O Innovation 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 H2O Innovation here for free.
What The Trend Of ROCE Can Tell Us
While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 8.4%. Basically the business is earning more per dollar of capital invested and in addition to that, 196% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
On a related note, the company's ratio of current liabilities to total assets has decreased to 22%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.
The Bottom Line
All in all, it's terrific to see that H2O Innovation is reaping the rewards from prior investments and is growing its capital base. Since the stock has returned a staggering 188% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if H2O Innovation can keep these trends up, it could have a bright future ahead.
One more thing to note, we've identified 3 warning signs with H2O Innovation and understanding them should be part of your investment process.
While H2O Innovation 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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