Prada's (HKG:1913) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Prada (HKG:1913) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Prada, this is the formula:

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

0.078 = €412m ÷ (€6.5b - €1.3b) (Based on the trailing twelve months to June 2021).

Therefore, Prada has an ROCE of 7.8%. On its own, that's a low figure but it's around the 7.0% average generated by the Luxury industry.

Check out our latest analysis for Prada

Above you can see how the current ROCE for Prada 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 Prada here for free.

How Are Returns Trending?

When we looked at the ROCE trend at Prada, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.8% from 12% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

What We Can Learn From Prada's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Prada is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 116% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Prada could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.

While Prada 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.