To avoid investing in a business that’s in decline, there’s a few financial metrics that can provide early indications of aging. More often than not, we’ll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don’t look too good at Revlon (NYSE:REV), so let’s see why.
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. The formula for this calculation on Revlon is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.027 = US$47m ÷ (US$3.0b – US$1.3b) (Based on the trailing twelve months to June 2020).
Thus, Revlon has an ROCE of 2.7%. Ultimately, that’s a low return and it under-performs the Personal Products industry average of 17%.
View our latest analysis for Revlon
Above you can see how the current ROCE for Revlon 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 Revlon here for free.
What Does the ROCE Trend For Revlon Tell Us?
There is reason to be cautious about Revlon, given the returns are trending downwards. About five years ago, returns on capital were 17%, however they’re now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren’t as high due potentially to new competition or smaller margins. If these trends continue, we wouldn’t expect Revlon to turn into a multi-bagger.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 42%, which has impacted the ROCE. Without this increase, it’s likely that ROCE would be even lower than 2.7%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company’s suppliers or short-term creditors, which can bring some risks of its own.What We Can Learn From Revlon’s ROCE
All in all, the lower returns from the same amount of capital employed aren’t exactly signs of a compounding machine. We expect this has contributed to the stock plummeting 79% during the last five years. Unless these trends revert to a more positive trajectory, we would look elsewhere.
Revlon does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those can’t be ignored…
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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