Grendene (BVMF:GRND3) Is Finding It Tricky To Allocate Its Capital

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. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Grendene (BVMF:GRND3) 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 Grendene, this is the formula:

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

0.094 = R$347m ÷ (R$4.1b - R$385m) (Based on the trailing twelve months to December 2023).

So, Grendene has an ROCE of 9.4%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 13%.

View our latest analysis for Grendene

Above you can see how the current ROCE for Grendene 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 Grendene for free.

What Can We Tell From Grendene's ROCE Trend?

In terms of Grendene's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 13% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Grendene to turn into a multi-bagger.

What We Can Learn From Grendene's ROCE

In summary, it's unfortunate that Grendene is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 14% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing to note, we've identified 1 warning sign with Grendene and understanding this should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.