Capital Allocation Trends At Red Eléctrica Corporación (BME:REE) Aren't Ideal

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Red Eléctrica Corporación (BME:REE) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Red Eléctrica Corporación is:

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

0.083 = €946m ÷ (€13b - €1.9b) (Based on the trailing twelve months to March 2022).

So, Red Eléctrica Corporación has an ROCE of 8.3%. Even though it's in line with the industry average of 7.7%, it's still a low return by itself.

See 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'd like, you can check out the forecasts from the analysts covering Red Eléctrica Corporación here for free.

What Does the ROCE Trend For Red Eléctrica Corporación Tell Us?

When we looked at the ROCE trend at Red Eléctrica Corporación, we didn't gain much confidence. To be more specific, ROCE has fallen from 12% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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.

The Key Takeaway

To conclude, we've found that Red Eléctrica Corporación is reinvesting in the business, but returns have been falling. And with the stock having returned a mere 24% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Red Eléctrica Corporación (of which 1 makes us a bit uncomfortable!) that you should know about.

While Red Eléctrica Corporación isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.