Here's What's Concerning About De Rucci Healthy Sleep's (SZSE:001323) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. In light of that, when we looked at De Rucci Healthy Sleep (SZSE:001323) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on De Rucci Healthy Sleep is:

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

0.17 = CN¥760m ÷ (CN¥7.1b - CN¥2.5b) (Based on the trailing twelve months to September 2023).

So, De Rucci Healthy Sleep has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 9.6% generated by the Consumer Durables industry.

View our latest analysis for De Rucci Healthy Sleep

In the above chart we have measured De Rucci Healthy Sleep'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 analyst report for De Rucci Healthy Sleep .

So How Is De Rucci Healthy Sleep's ROCE Trending?

In terms of De Rucci Healthy Sleep's historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 39%, but since then they've fallen to 17%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, De Rucci Healthy Sleep has decreased its current liabilities to 36% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

We're a bit apprehensive about De Rucci Healthy Sleep because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 32% return over the last year, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

De Rucci Healthy Sleep does have some risks though, and we've spotted 1 warning sign for De Rucci Healthy Sleep that you might be interested in.

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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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.