Richelieu Hardware (TSE:RCH) Is Very Good At Capital Allocation

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, the ROCE of Richelieu Hardware (TSE:RCH) looks great, so lets see what the trend can tell us.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Richelieu Hardware, this is the formula:

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

0.27 = CA$236m ÷ (CA$1.2b - CA$300m) (Based on the trailing twelve months to August 2022).

Therefore, Richelieu Hardware has an ROCE of 27%. In absolute terms that's a great return and it's even better than the Trade Distributors industry average of 19%.

Our analysis indicates that RCH is potentially overvalued!

Above you can see how the current ROCE for Richelieu Hardware 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.

How Are Returns Trending?

Investors would be pleased with what's happening at Richelieu Hardware. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 27%. Basically the business is earning more per dollar of capital invested and in addition to that, 104% more capital is being employed now too. So we're very much inspired by what we're seeing at Richelieu Hardware thanks to its ability to profitably reinvest capital.

In Conclusion...

In summary, it's great to see that Richelieu Hardware 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. Considering the stock has delivered 16% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

Richelieu Hardware does have some risks though, and we've spotted 1 warning sign for Richelieu Hardware that you might be interested in.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.