Investors Will Want Adolfo Domínguez's (BME:ADZ) Growth In ROCE To Persist

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. With that in mind, we've noticed some promising trends at Adolfo Domínguez (BME:ADZ) so let's look a bit deeper.

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. Analysts use this formula to calculate it for Adolfo Domínguez:

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

0.022 = €1.1m ÷ (€104m - €52m) (Based on the trailing twelve months to August 2023).

Therefore, Adolfo Domínguez has an ROCE of 2.2%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 16%.

Check out our latest analysis for Adolfo Domínguez

In the above chart we have measured Adolfo Domínguez'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 Adolfo Domínguez for free.

How Are Returns Trending?

Shareholders will be relieved that Adolfo Domínguez has broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 2.2% on its capital. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 50% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

The Key Takeaway

To sum it up, Adolfo Domínguez is collecting higher returns from the same amount of capital, and that's impressive. And since the stock has fallen 34% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.

Adolfo Domínguez does have some risks though, and we've spotted 2 warning signs for Adolfo Domínguez that you might be interested in.

While Adolfo Domínguez isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.