Guararapes Confecções (BVMF:GUAR3) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 Guararapes Confecções (BVMF:GUAR3) and its ROCE trend, we weren't exactly thrilled.

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 Guararapes Confecções, this is the formula:

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

0.033 = R$285m ÷ (R$13b - R$4.4b) (Based on the trailing twelve months to June 2021).

So, Guararapes Confecções has an ROCE of 3.3%. Ultimately, that's a low return and it under-performs the Luxury industry average of 11%.

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, you can check out the forecasts from the analysts covering Guararapes Confecções here for free.

What Can We Tell From Guararapes Confecções' ROCE Trend?

When we looked at the ROCE trend at Guararapes Confecções, we didn't gain much confidence. Around five years ago the returns on capital were 7.8%, but since then they've fallen to 3.3%. 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 may take some time before the company starts to see any change in earnings from these investments.

Our Take On Guararapes Confecções' ROCE

Bringing it all together, while we're somewhat encouraged by Guararapes Confecções' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 76% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Guararapes Confecções does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is a bit unpleasant...

While Guararapes Confecções isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.
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