Capital Allocation Trends At RS2 (MTSE:RS2) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at RS2 (MTSE:RS2) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for RS2:

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

0.069 = €2.2m ÷ (€49m - €17m) (Based on the trailing twelve months to December 2023).

Thus, RS2 has an ROCE of 6.9%. In absolute terms, that's a low return and it also under-performs the Software industry average of 13%.

See our latest analysis for RS2

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 RS2 has performed in the past in other metrics, you can view this free graph of RS2's past earnings, revenue and cash flow.

So How Is RS2's ROCE Trending?

On the surface, the trend of ROCE at RS2 doesn't inspire confidence. To be more specific, ROCE has fallen from 31% over the last five years. However it looks like RS2 might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 34%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 6.9%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

In Conclusion...

In summary, RS2 is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 37% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

RS2 does have some risks though, and we've spotted 2 warning signs for RS2 that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com