Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Restoque Comércio e Confecções de Roupas' (BVMF:LLIS3) returns on capital, so let's have a look.
What is Return On Capital Employed (ROCE)?
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 Restoque Comércio e Confecções de Roupas, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.35 = R$586m ÷ (R$2.1b - R$429m) (Based on the trailing twelve months to September 2021).
Thus, Restoque Comércio e Confecções de Roupas has an ROCE of 35%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Restoque Comércio e Confecções de Roupas' ROCE against it's prior returns. If you'd like to look at how Restoque Comércio e Confecções de Roupas has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Restoque Comércio e Confecções de Roupas' ROCE Trend?
We're pretty happy with how the ROCE has been trending at Restoque Comércio e Confecções de Roupas. We found that the returns on capital employed over the last five years have risen by 536%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 21% less than it was five years ago, which can be indicative of a business that's improving its efficiency. Restoque Comércio e Confecções de Roupas may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.
One more thing to note, Restoque Comércio e Confecções de Roupas has decreased current liabilities to 20% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
The Bottom Line On Restoque Comércio e Confecções de Roupas' ROCE
In a nutshell, we're pleased to see that Restoque Comércio e Confecções de Roupas has been able to generate higher returns from less capital. However the stock is down a substantial 95% in the last five years so there could be other areas of the business hurting its prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.
Restoque Comércio e Confecções de Roupas does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...
High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.