What We Make Of Luna Innovations' (NASDAQ:LUNA) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Speaking of which, we noticed some great changes in Luna Innovations' (NASDAQ:LUNA) returns on capital, so let's have a look.

What is Return On Capital Employed (ROCE)?

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 Luna Innovations, this is the formula:

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

0.083 = US$6.4m ÷ (US$91m - US$14m) (Based on the trailing twelve months to June 2020).

Thus, Luna Innovations has an ROCE of 8.3%. On its own, that's a low figure but it's around the 10% average generated by the Electronic industry.

Check out our latest analysis for Luna Innovations

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 Does the ROCE Trend For Luna Innovations Tell Us?

Luna Innovations has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 8.3% which is a sight for sore eyes. Not only that, but the company is utilizing 119% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

One more thing to note, Luna Innovations has decreased current liabilities to 16% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. This tells us that Luna Innovations has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.

Our Take On Luna Innovations' ROCE

To the delight of most shareholders, Luna Innovations has now broken into profitability. And a remarkable 495% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

One more thing to note, we've identified 1 warning sign with Luna Innovations and understanding it should be part of your investment process.

While Luna Innovations may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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