This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on Reverse Corp Limited (ASX:REF) stock.
Buying Reverse makes you a partial owner of the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. To understand Reverse’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.View our latest analysis for Reverse
Calculating Return On Capital Employed for REF
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. Accordingly, before you invest you need to assess the capital returns that the company has produced with reference to a certain benchmark to ensure that you are confident in the business’ ability to grow your capital at a level that grants an investment over other companies. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Reverse is good at growing investor capital. REF’s ROCE is calculated below:
ROCE Calculation for REF
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = AU$586.02K ÷ (AU$9.81M – AU$864.37K) = 6.55%
As you can see, REF earned A$6.5 from every A$100 you invested over the previous twelve months. This makes Reverse unattractive when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future, investor capital will be able to compound over time, but not to the extent investors should be aiming for.
A deeper look
The underperforming ROCE is not ideal for Reverse investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, REF’s ROCE may increase, in which case your portfolio could benefit from holding the company. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Looking three years in the past, it is evident that REF’s ROCE has deteriorated from 33.50%, indicating the company’s capital returns have declined. With this, the current earnings of AU$586.02K actually declined from AU$2.89M whilst capital employed has increased due to a hike in the level of total assets employed , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.
Reverse’s ROCE has decreased in the recent past and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. However, it is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as the management team and valuation. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate REF or move on to other alternatives.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Reverse’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Valuation: What is REF worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether REF is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.