Rumo's (BVMF:RAIL3) Returns On Capital Are Heading Higher

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, Rumo (BVMF:RAIL3) looks quite promising in regards to its trends of return on capital.

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 Rumo is:

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

0.054 = R$2.0b ÷ (R$42b - R$3.7b) (Based on the trailing twelve months to March 2021).

Thus, Rumo has an ROCE of 5.4%. Ultimately, that's a low return and it under-performs the Transportation industry average of 8.0%.

See our latest analysis for Rumo

Above you can see how the current ROCE for Rumo compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Rumo's ROCE Trend?

We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. Over the last five years, returns on capital employed have risen substantially to 5.4%. Basically the business is earning more per dollar of capital invested and in addition to that, 221% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 8.9%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Rumo has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.

The Key Takeaway

In summary, it's great to see that Rumo can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with a respectable 36% awarded to those who held the stock over the last three years, you could argue that these developments are starting to get the attention they deserve. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

One final note, you should learn about the 2 warning signs we've spotted with Rumo (including 1 which is potentially serious) .

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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