Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. In light of that, when we looked at RTX (CPH:RTX) and its ROCE trend, we weren't exactly thrilled.
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 RTX:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = kr.43m ÷ (kr.470m - kr.74m) (Based on the trailing twelve months to December 2020).
So, RTX has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 10% generated by the Communications industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for RTX's ROCE against it's prior returns. If you're interested in investigating RTX's past further, check out this free graph of past earnings, revenue and cash flow.
So How Is RTX's ROCE Trending?
When we looked at the ROCE trend at RTX, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 11% from 19% 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.
The Bottom Line On RTX's ROCE
In summary, we're somewhat concerned by RTX's diminishing returns on increasing amounts of capital. Since the stock has skyrocketed 148% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
RTX does have some risks though, and we've spotted 3 warning signs for RTX 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. 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.
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