The Returns On Capital At Relaxo Footwears (NSE:RELAXO) Don't Inspire Confidence

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. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So while Relaxo Footwears (NSE:RELAXO) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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 Relaxo Footwears, this is the formula:

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

0.21 = ₹3.2b ÷ (₹19b - ₹4.2b) (Based on the trailing twelve months to December 2020).

Therefore, Relaxo Footwears has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 9.6% earned by companies in a similar industry.

View our latest analysis for Relaxo Footwears

Historical performance is a great place to start when researching a stock so above you can see the gauge for Relaxo Footwears' ROCE against it's prior returns. If you'd like to look at how Relaxo Footwears has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Relaxo Footwears, we didn't gain much confidence. Historically returns on capital were even higher at 34%, but they have dropped over the last five years. 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.

On a related note, Relaxo Footwears has decreased its current liabilities to 21% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Relaxo Footwears' ROCE

In summary, we're somewhat concerned by Relaxo Footwears' diminishing returns on increasing amounts of capital. Since the stock has skyrocketed 276% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

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

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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