There Are Reasons To Feel Uneasy About Relatech's (BIT:RLT) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. However, after investigating Relatech (BIT:RLT), we don't think it's current trends fit the mold of a multi-bagger.

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)

0.10 = €7.4m ÷ (€104m - €33m) (Based on the trailing twelve months to June 2023).

So, Relatech has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 6.4% it's much better.

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 to see what analysts are forecasting going forward, you should check out our free analyst report for Relatech .

So How Is Relatech's ROCE Trending?

On the surface, the trend of ROCE at Relatech doesn't inspire confidence. To be more specific, ROCE has fallen from 45% over the last five years. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Relatech has decreased its current liabilities to 32% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 On Relatech's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Relatech is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 28% over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Relatech does have some risks, we noticed 2 warning signs (and 1 which is potentially serious) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.