Should You Be Impressed By Rallye's (EPA:RAL) Returns on Capital?

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. 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 Rallye (EPA:RAL), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Rallye, this is the formula:

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

0.056 = €1.1b ÷ (€32b - €12b) (Based on the trailing twelve months to June 2020).

Thus, Rallye has an ROCE of 5.6%. Ultimately, that's a low return and it under-performs the Consumer Retailing industry average of 9.0%.

See our latest analysis for Rallye

Historical performance is a great place to start when researching a stock so above you can see the gauge for Rallye's ROCE against it's prior returns. If you'd like to look at how Rallye has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Rallye Tell Us?

We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 27% in that same period. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.

What We Can Learn From Rallye's ROCE

It's a shame to see that Rallye is effectively shrinking in terms of its capital base. Since the stock has declined 23% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

If you want to know some of the risks facing Rallye we've found 4 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

While Rallye 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. 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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