Guararapes Confecções (BVMF:GUAR3) Could Be Struggling To Allocate Capital

What underlying fundamental trends can indicate that a company might be in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into Guararapes Confecções (BVMF:GUAR3), the trends above didn't look too great.

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. Analysts use this formula to calculate it for Guararapes Confecções:

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

0.072 = R$585m ÷ (R$13b - R$5.3b) (Based on the trailing twelve months to June 2024).

Thus, Guararapes Confecções has an ROCE of 7.2%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 12%.

Check out our latest analysis for Guararapes Confecções

In the above chart we have measured Guararapes Confecções' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Guararapes Confecções .

What The Trend Of ROCE Can Tell Us

In terms of Guararapes Confecções' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 16%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Guararapes Confecções to turn into a multi-bagger.

On a side note, Guararapes Confecções' current liabilities have increased over the last five years to 39% of total assets, effectively distorting the ROCE to some degree. 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

In summary, it's unfortunate that Guararapes Confecções is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 56% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Guararapes Confecções does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is significant...

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. 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.