Investors Could Be Concerned With Rocky Mountain Liquor's (CVE:RUM) Returns On Capital

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Rocky Mountain Liquor (CVE:RUM), so let's see why.

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 Rocky Mountain Liquor, this is the formula:

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

0.03 = CA$541k ÷ (CA$23m - CA$5.1m) (Based on the trailing twelve months to September 2024).

Thus, Rocky Mountain Liquor has an ROCE of 3.0%. In absolute terms, that's a low return and it also under-performs the Consumer Retailing industry average of 12%.

View our latest analysis for Rocky Mountain Liquor

Historical performance is a great place to start when researching a stock so above you can see the gauge for Rocky Mountain Liquor's ROCE against it's prior returns. If you'd like to look at how Rocky Mountain Liquor has performed in the past in other metrics, you can view this free graph of Rocky Mountain Liquor's past earnings, revenue and cash flow.

The Trend Of ROCE

There is reason to be cautious about Rocky Mountain Liquor, given the returns are trending downwards. About five years ago, returns on capital were 5.4%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Rocky Mountain Liquor becoming one if things continue as they have.

On a related note, Rocky Mountain Liquor has decreased its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Rocky Mountain Liquor's ROCE

In summary, it's unfortunate that Rocky Mountain Liquor is generating lower returns from the same amount of capital. Since the stock has skyrocketed 157% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you'd like to know about the risks facing Rocky Mountain Liquor, we've discovered 3 warning signs that 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.