Our Take On The Returns On Capital At Ridley (ASX:RIC)

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Having said that, from a first glance at Ridley (ASX:RIC) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. To calculate this metric for Ridley, this is the formula:

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

0.12 = AU$33m ÷ (AU$647m - AU$380m) (Based on the trailing twelve months to June 2020).

Thus, Ridley has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 5.2% generated by the Food industry.

Check out our latest analysis for Ridley

Above you can see how the current ROCE for Ridley compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Ridley here for free.

The Trend Of ROCE

Over the past five years, Ridley's ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at Ridley in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. With fewer investment opportunities, it makes sense that Ridley has been paying out a decent 57% of its earnings to shareholders. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 59% of total assets, this reported ROCE would probably be less than12% because total capital employed would be higher.The 12% ROCE could be even lower if current liabilities weren't 59% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

The Key Takeaway

In summary, Ridley isn't compounding its earnings but is generating stable returns on the same amount of capital employed. And investors appear hesitant that the trends will pick up because the stock has fallen 23% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

Ridley does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those can't be ignored...

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.

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This article by Simply Wall St is general in nature. 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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