Reliance Worldwide (ASX:RWC) May Have Issues Allocating Its Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Reliance Worldwide (ASX:RWC), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Reliance Worldwide is:

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

0.11 = US$212m ÷ (US$2.1b - US$201m) (Based on the trailing twelve months to June 2022).

Therefore, Reliance Worldwide has an ROCE of 11%. That's a pretty standard return and it's in line with the industry average of 11%.

See our latest analysis for Reliance Worldwide

In the above chart we have measured Reliance Worldwide's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Reliance Worldwide.

How Are Returns Trending?

Unfortunately, the trend isn't great with ROCE falling from 21% five years ago, while capital employed has grown 409%. Usually this isn't ideal, but given Reliance Worldwide conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Reliance Worldwide might not have received a full period of earnings contribution from it. Additionally, we found that Reliance Worldwide's most recent EBIT figure is around the same as the prior year, so we'd attribute the drop in ROCE mostly to the capital raise.

On a related note, Reliance Worldwide has decreased its current liabilities to 9.6% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Reliance Worldwide is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 26% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

One final note, you should learn about the 2 warning signs we've spotted with Reliance Worldwide (including 1 which is potentially serious) .

While Reliance Worldwide 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.

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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.