How Well Is Valid Soluções (BVMF:VLID3) Allocating Its Capital?

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into Valid Soluções (BVMF:VLID3), the trends above didn't look too great.

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 Valid Soluções, this is the formula:

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

0.043 = R$87m ÷ (R$3.1b - R$1.0b) (Based on the trailing twelve months to September 2020).

Thus, Valid Soluções has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 9.5%.

Check out our latest analysis for Valid Soluções

Above you can see how the current ROCE for Valid Soluções 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 Valid Soluções here for free.

The Trend Of ROCE

There is reason to be cautious about Valid Soluções, given the returns are trending downwards. To be more specific, the ROCE was 11% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Valid Soluções to turn into a multi-bagger.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 34%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 67% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 3 warning signs with Valid Soluções (at least 1 which doesn't sit too well with us) , and understanding these would certainly be useful.

While Valid Soluções 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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