Returns At Rolls-Royce Holdings (LON:RR.) Are On The Way Up

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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. With that in mind, we've noticed some promising trends at Rolls-Royce Holdings (LON:RR.) so let's look a bit deeper.

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. To calculate this metric for Rolls-Royce Holdings, this is the formula:

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

0.038 = UK£645m ÷ (UK£31b - UK£14b) (Based on the trailing twelve months to June 2022).

Thus, Rolls-Royce Holdings has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Aerospace & Defense industry average of 10.0%.

View our latest analysis for Rolls-Royce Holdings

Above you can see how the current ROCE for Rolls-Royce Holdings 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 Rolls-Royce Holdings here for free.

So How Is Rolls-Royce Holdings' ROCE Trending?

While there are companies with higher returns on capital out there, we still find the trend at Rolls-Royce Holdings promising. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 1,204% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

Another thing to note, Rolls-Royce Holdings has a high ratio of current liabilities to total assets of 45%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Rolls-Royce Holdings' ROCE

To sum it up, Rolls-Royce Holdings is collecting higher returns from the same amount of capital, and that's impressive. And since the stock has fallen 61% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.

On a final note, we've found 1 warning sign for Rolls-Royce Holdings that we think you should be aware of.

While Rolls-Royce Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.