Redox (ASX:RDX) May Have Issues Allocating Its Capital

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. Having said that, while the ROCE is currently high for Redox (ASX:RDX), we aren't jumping out of our chairs because returns are decreasing.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Redox, this is the formula:

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

0.23 = AU$126m ÷ (AU$702m - AU$143m) (Based on the trailing twelve months to June 2024).

Thus, Redox has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Trade Distributors industry average of 11%.

View our latest analysis for Redox

In the above chart we have measured Redox'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 Redox for free.

What Can We Tell From Redox's ROCE Trend?

On the surface, the trend of ROCE at Redox doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 33% where it was five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Redox has decreased its current liabilities to 20% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Redox's ROCE

Bringing it all together, while we're somewhat encouraged by Redox's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 69% over the last year, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Redox could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation for RDX on our platform quite valuable.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.