Returns On Capital At Reliance Worldwide (ASX:RWC) Paint A Concerning Picture

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. In light of that, when we looked at Reliance Worldwide (ASX:RWC) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Reliance Worldwide, this is the formula:

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).

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

Our analysis indicates that RWC is potentially undervalued!

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.

What Does the ROCE Trend For Reliance Worldwide Tell Us?

The trend of ROCE doesn't look fantastic because it's fallen from 21% five years ago, while the business's capital employed increased by 409%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Reliance Worldwide probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.

On a side note, Reliance Worldwide has done well to pay down its current liabilities to 9.6% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Reliance Worldwide's ROCE

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 growth trends haven't led to growth returns though, since the stock has fallen 10% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you want to know some of the risks facing Reliance Worldwide we've found 2 warning signs (1 is significant!) that you should be aware of before investing here.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.