When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. Having said that, after a brief look, Reef Casino Trust (ASX:RCT) we aren't filled with optimism, but let's investigate further.
Return On Capital Employed (ROCE): What is it?
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 Reef Casino Trust, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.023 = AU$1.7m ÷ (AU$77m - AU$1.7m) (Based on the trailing twelve months to June 2020).
So, Reef Casino Trust has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 7.7%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Reef Casino Trust's ROCE against it's prior returns. If you'd like to look at how Reef Casino Trust has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Reef Casino Trust's ROCE Trend?
The trend of ROCE at Reef Casino Trust is showing some signs of weakness. Unfortunately, returns have declined substantially over the last five years to the 2.3% we see today. On top of that, the business is utilizing 23% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
The Key Takeaway
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. And long term shareholders have watched their investments stay flat over the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing: We've identified 5 warning signs with Reef Casino Trust (at least 3 which are potentially serious) , and understanding them would certainly be useful.
While Reef Casino Trust 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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