Rainbow Digital Commercial (SZSE:002419) May Have Issues Allocating Its Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Rainbow Digital Commercial (SZSE:002419), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Rainbow Digital Commercial:

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

0.009 = CN¥146m ÷ (CN¥27b - CN¥11b) (Based on the trailing twelve months to June 2024).

Thus, 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 4.2%.

View our latest analysis for Rainbow Digital Commercial

In the above chart we have measured Rainbow Digital Commercial'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 Rainbow Digital Commercial .

What Can We Tell From Rainbow Digital Commercial's ROCE Trend?

When we looked at the ROCE trend at Rainbow Digital Commercial, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 0.9% from 15% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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 40% 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. 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

To conclude, we've found that Rainbow Digital Commercial is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 44% in the last five years. Therefore based on the analysis done in this article, we don't think Rainbow Digital Commercial has the makings of a multi-bagger.

On a separate note, we've found 2 warning signs for Rainbow Digital Commercial you'll probably want to know about.

While Rainbow Digital Commercial may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.