There Are Reasons To Feel Uneasy About Red Eléctrica Corporación's (BME:RED) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Red Eléctrica Corporación (BME:RED) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for Red Eléctrica Corporación:

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

0.078 = €938m ÷ (€15b - €2.5b) (Based on the trailing twelve months to June 2022).

Thus, Red Eléctrica Corporación has an ROCE of 7.8%. In absolute terms, that's a low return but it's around the Electric Utilities industry average of 7.4%.

Check out our latest analysis for Red Eléctrica Corporación

In the above chart we have measured Red Eléctrica Corporación'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 report on analyst forecasts for the company.

How Are Returns Trending?

In terms of Red Eléctrica Corporación's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 7.8% from 11% five years ago. However it looks like Red Eléctrica Corporación 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.

In Conclusion...

To conclude, we've found that Red Eléctrica Corporación is reinvesting in the business, but returns have been falling. And investors may be recognizing these trends since the stock has only returned a total of 11% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing: We've identified 2 warning signs with Red Eléctrica Corporación (at least 1 which is significant) , and understanding them would certainly be useful.

While Red Eléctrica Corporación 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.