Guararapes Confecções (BVMF:GUAR3) Will Want To Turn Around Its Return Trends

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. 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?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Guararapes Confecções is:

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

0.042 = R$346m ÷ (R$14b - R$5.8b) (Based on the trailing twelve months to June 2022).

So, Guararapes Confecções has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Luxury industry average of 11%.

Check out the opportunities and risks within the BR Luxury industry.

Above you can see how the current ROCE for Guararapes Confecções 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 Guararapes Confecções here for free.

What Does the ROCE Trend For Guararapes Confecções Tell Us?

In terms of Guararapes Confecções' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 14%, but since then they've fallen to 4.2%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a separate but related note, it's important to know that Guararapes Confecções has a current liabilities to total assets ratio of 41%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Guararapes Confecções' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Guararapes Confecções. And there could be an opportunity here if other metrics look good too, because the stock has declined 45% in the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Guararapes Confecções does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those can't be ignored...

While Guararapes Confecções 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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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.