Returns On Capital Signal Tricky Times Ahead For Guararapes Confecções (BVMF:GUAR3)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. 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?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed 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)

0.04 = R$327m ÷ (R$14b - R$5.9b) (Based on the trailing twelve months to March 2022).

So, Guararapes Confecções has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Luxury industry average of 10%.

View 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 report for Guararapes Confecções.

What Can We Tell From Guararapes Confecções' ROCE Trend?

In terms of Guararapes Confecções' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 12% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 42%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line

While returns have fallen for Guararapes Confecções in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 30% 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.

Like most companies, Guararapes Confecções does come with some risks, and we've found 3 warning signs that you should be aware of.

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.