The Returns At Prada (HKG:1913) Provide Us With Signs Of What's To Come

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at Prada (HKG:1913), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on Prada is:

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

0.014 = €73m ÷ (€6.8b - €1.4b) (Based on the trailing twelve months to June 2020).

Therefore, Prada has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Luxury industry average of 9.2%.

View our latest analysis for Prada

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

What Can We Tell From Prada's ROCE Trend?

On the surface, the trend of ROCE at Prada doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.4% from 17% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

What We Can Learn From Prada's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Prada have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these poor fundamentals, the stock has gained a huge 134% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a separate note, we've found 1 warning sign for Prada you'll probably want to know about.

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. 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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