What Do The Returns On Capital At Relaxo Footwears (NSE:RELAXO) Tell Us?

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at Relaxo Footwears (NSE:RELAXO), it didn't seem to tick all of these boxes.

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. 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)

0.18 = ₹2.7b ÷ (₹19b - ₹4.2b) (Based on the trailing twelve months to September 2020).

Thus, Relaxo Footwears has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 8.3% generated by the Luxury industry.

Check out our latest analysis for Relaxo Footwears

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. 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. Around five years ago the returns on capital were 33%, but since then they've fallen to 18%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Relaxo Footwears has decreased its current liabilities to 21% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

We're a bit apprehensive about Relaxo Footwears because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these poor fundamentals, the stock has gained a huge 291% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you'd like to know about the risks facing Relaxo Footwears, we've discovered 2 warning signs that you should be aware of.

While Relaxo Footwears 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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