Traumhaus (ETR:TRU) Might Be Having Difficulty Using Its Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Traumhaus (ETR:TRU) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Traumhaus is:

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

0.037 = €3.8m ÷ (€154m - €54m) (Based on the trailing twelve months to December 2022).

Thus, Traumhaus has an ROCE of 3.7%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 4.9%.

See our latest analysis for Traumhaus

Above you can see how the current ROCE for Traumhaus compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Traumhaus here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Traumhaus, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.7% from 26% five years ago. 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, Traumhaus has decreased its current liabilities to 35% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Traumhaus' ROCE

In summary, we're somewhat concerned by Traumhaus' diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 48% from where it was three years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Traumhaus does have some risks, we noticed 5 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.