Grendene (BVMF:GRND3) Will Be Hoping To Turn Its Returns On Capital Around

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. In light of that, when we looked at Grendene (BVMF:GRND3) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed 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)

0.081 = R$349m ÷ (R$4.7b - R$351m) (Based on the trailing twelve months to December 2020).

So, Grendene has an ROCE of 8.1%. On its own that's a low return, but compared to the average of 5.4% generated by the Luxury industry, it's much better.

Check out our latest analysis for Grendene

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Grendene's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Grendene doesn't inspire confidence. Over the last five years, returns on capital have decreased to 8.1% from 17% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

The Bottom Line

In summary, Grendene is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 69% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing: We've identified 3 warning signs with Grendene (at least 1 which is potentially serious) , and understanding them would certainly be useful.

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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