Rolls-Royce Holdings' (LON:RR.) Returns On Capital Are Heading Higher

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Rolls-Royce Holdings' (LON:RR.) returns on capital, so let's have a look.

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 Rolls-Royce Holdings:

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

0.051 = UK£787m ÷ (UK£29b - UK£14b) (Based on the trailing twelve months to December 2022).

Therefore, Rolls-Royce Holdings has an ROCE of 5.1%. In absolute terms, that's a low return and it also under-performs the Aerospace & Defense industry average of 10.0%.

View our latest analysis for Rolls-Royce Holdings

In the above chart we have measured Rolls-Royce Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Rolls-Royce Holdings.

SWOT Analysis for Rolls-Royce Holdings

What The Trend Of ROCE Can Tell Us

Rolls-Royce Holdings is showing promise given that its ROCE is trending up and to the right. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 70% in that same time. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. 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.

On a separate but related note, it's important to know that Rolls-Royce Holdings has a current liabilities to total assets ratio of 47%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

In summary, we're delighted to see that Rolls-Royce Holdings has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Astute investors may have an opportunity here because the stock has declined 46% in the last five years. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Rolls-Royce Holdings (of which 1 is a bit unpleasant!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.