Redox's (ASX:RDX) Returns On Capital Not Reflecting Well On The Business

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. 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.

Our free stock report includes 1 warning sign investors should be aware of before investing in Redox. Read for free now.

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 Redox, this is the formula:

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

0.21 = AU$117m ÷ (AU$736m - AU$167m) (Based on the trailing twelve months to December 2024).

Thus, Redox has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Trade Distributors industry average of 12%.

View our latest analysis for Redox

Above you can see how the current ROCE for Redox 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 analyst report for Redox .

The Trend Of ROCE

When we looked at the ROCE trend at Redox, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 33%. 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 side note, Redox has done well to pay down its current liabilities to 23% of total assets. That could partly explain why the ROCE has dropped. 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Redox's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 3.5% over the last year, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

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

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.