There Are Reasons To Feel Uneasy About Rede D'Or São Luiz's (BVMF:RDOR3) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. Although, when we looked at Rede D'Or São Luiz (BVMF:RDOR3), it didn't seem to tick all of these boxes.

Understanding 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. The formula for this calculation on Rede D'Or São Luiz is:

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

0.077 = R$3.5b ÷ (R$51b - R$5.1b) (Based on the trailing twelve months to September 2021).

Thus, Rede D'Or São Luiz has an ROCE of 7.7%. In absolute terms, that's a low return and it also under-performs the Healthcare industry average of 11%.

Check out our latest analysis for Rede D'Or São Luiz

In the above chart we have measured Rede D'Or São Luiz's 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 Rede D'Or São Luiz here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Rede D'Or São Luiz doesn't inspire confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 7.7%. 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.

The Bottom Line

While returns have fallen for Rede D'Or São Luiz in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 20% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

On a final note, we found 2 warning signs for Rede D'Or São Luiz (1 makes us a bit uncomfortable) you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.