Relatech (BIT:RLT) May Have Issues Allocating Its Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Relatech (BIT:RLT) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

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 Relatech:

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

0.15 = €3.4m ÷ (€31m - €7.3m) (Based on the trailing twelve months to December 2020).

Therefore, Relatech has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 11% generated by the Software industry.

View our latest analysis for Relatech

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

So How Is Relatech's ROCE Trending?

On the surface, the trend of ROCE at Relatech doesn't inspire confidence. Around four years ago the returns on capital were 49%, but since then they've fallen to 15%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Relatech has decreased its current liabilities to 24% 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.

The Key Takeaway

To conclude, we've found that Relatech is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 45% over the last year, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Like most companies, Relatech does come with some risks, and we've found 1 warning sign that you should be aware of.

While Relatech 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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