Rainbow Digital Commercial (SZSE:002419) Is Reinvesting At Lower Rates Of Return

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating Rainbow Digital Commercial (SZSE:002419), we don't think it's current trends fit the mold of a multi-bagger.

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 Rainbow Digital Commercial is:

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

0.0091 = CN¥142m ÷ (CN¥27b - CN¥11b) (Based on the trailing twelve months to September 2024).

Therefore, Rainbow Digital Commercial has an ROCE of 0.9%. In absolute terms, that's a low return and it also under-performs the Multiline Retail industry average of 3.9%.

See our latest analysis for Rainbow Digital Commercial

Above you can see how the current ROCE for Rainbow Digital Commercial compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Rainbow Digital Commercial .

How Are Returns Trending?

In terms of Rainbow Digital Commercial's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 14% over the last five years. However it looks like Rainbow Digital Commercial might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Rainbow Digital Commercial has done well to pay down its current liabilities to 41% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

What We Can Learn From Rainbow Digital Commercial's ROCE

Bringing it all together, while we're somewhat encouraged by Rainbow Digital Commercial's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 36% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing, we've spotted 3 warning signs facing Rainbow Digital Commercial that you might find interesting.

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.