R.E.A. Holdings (LON:RE.) Could Be Struggling To Allocate Capital

When researching a stock for investment, what can tell us that the company is in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. On that note, looking into R.E.A. Holdings (LON:RE.), we weren't too upbeat about how things were going.

Understanding 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. Analysts use this formula to calculate it for R.E.A. Holdings:

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

0.0034 = US$1.7m ÷ (US$581m - US$76m) (Based on the trailing twelve months to June 2020).

Therefore, R.E.A. Holdings has an ROCE of 0.3%. Ultimately, that's a low return and it under-performs the Food industry average of 8.8%.

Check out our latest analysis for R.E.A. Holdings

In the above chart we have measured R.E.A. 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 R.E.A. Holdings.

What Does the ROCE Trend For R.E.A. Holdings Tell Us?

There is reason to be cautious about R.E.A. Holdings, given the returns are trending downwards. About five years ago, returns on capital were 0.9%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect R.E.A. Holdings to turn into a multi-bagger.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. We expect this has contributed to the stock plummeting 80% during the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing, we've spotted 2 warning signs facing R.E.A. Holdings that you might find interesting.

While R.E.A. 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.

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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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