When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. In light of that, from a first glance at Retail Food Group (ASX:RFG), we've spotted some signs that it could be struggling, so let's investigate.
What is Return On Capital Employed (ROCE)?
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 Retail Food Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = AU$9.9m ÷ (AU$362m - AU$106m) (Based on the trailing twelve months to December 2021).
So, Retail Food Group has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 7.9%.
Above you can see how the current ROCE for Retail Food Group 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 report for Retail Food Group.
What Does the ROCE Trend For Retail Food Group Tell Us?
The trend of returns that Retail Food Group is generating are raising some concerns. To be more specific, today's ROCE was 12% five years ago but has since fallen to 3.9%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 66% over that same period. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 29%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.9%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
The Bottom Line
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Unsurprisingly then, the stock has dived 99% over the last five years, so investors are recognizing these changes and don't like the company's prospects. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
On a final note, we've found 3 warning signs for Retail Food Group that we think you should be aware of.
While Retail Food Group isn't earning the highest return, check out this free list of companies that are 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.
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