Falabella (SNSE:FALABELLA) Could Be Struggling To Allocate Capital

What are the early trends we should look for to identify a stock that could 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Falabella (SNSE:FALABELLA) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Falabella:

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

0.047 = CL$879b ÷ (CL$24t - CL$4.6t) (Based on the trailing twelve months to September 2022).

Therefore, Falabella has an ROCE of 4.7%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.3%.

Check out the opportunities and risks within the XX Multiline Retail industry.

In the above chart we have measured Falabella's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Falabella Tell Us?

On the surface, the trend of ROCE at Falabella doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.7% from 7.9% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Falabella is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 70% over the last five years, 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.

Falabella does have some risks, we noticed 3 warning signs (and 1 which can't be ignored) we think you should know about.

While Falabella isn't earning the highest return, check out this free list of companies that are 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.