Be Wary Of Redrow (LON:RDW) And Its Returns On Capital

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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Redrow (LON:RDW) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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. To calculate this metric for Redrow, this is the formula:

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

0.18 = UK£399m ÷ (UK£3.1b - UK£865m) (Based on the trailing twelve months to July 2023).

Therefore, Redrow has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 11% generated by the Consumer Durables industry.

See our latest analysis for Redrow

In the above chart we have measured Redrow'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 Redrow here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Redrow doesn't inspire confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 18%. However it looks like Redrow 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.

The Key Takeaway

To conclude, we've found that Redrow is reinvesting in the business, but returns have been falling. And with the stock having returned a mere 34% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

If you want to know some of the risks facing Redrow we've found 2 warning signs (1 is potentially serious!) that you should be aware of before investing here.

While Redrow 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.