Reditus Sociedade Gestora de Participações Sociais (ELI:RED) May Have Issues Allocating Its Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within Reditus Sociedade Gestora de Participações Sociais (ELI:RED), we weren't too hopeful.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Reditus Sociedade Gestora de Participações Sociais is:

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

0.02 = €1.5m ÷ (€163m - €86m) (Based on the trailing twelve months to June 2020).

Thus, Reditus Sociedade Gestora de Participações Sociais has an ROCE of 2.0%. Ultimately, that's a low return and it under-performs the IT industry average of 12%.

See our latest analysis for Reditus Sociedade Gestora de Participações Sociais

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

What Can We Tell From Reditus Sociedade Gestora de Participações Sociais' ROCE Trend?

In terms of Reditus Sociedade Gestora de Participações Sociais' historical ROCE trend, it isn't fantastic. To be more specific, today's ROCE was 4.9% five years ago but has since fallen to 2.0%. On top of that, the business is utilizing 40% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a side note, Reditus Sociedade Gestora de Participações Sociais' current liabilities have increased over the last five years to 53% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.0%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

What We Can Learn From Reditus Sociedade Gestora de Participações Sociais' ROCE

In summary, it's unfortunate that Reditus Sociedade Gestora de Participações Sociais is shrinking its capital base and also generating lower returns. Unsurprisingly then, the stock has dived 88% over the last five years, so investors are recognizing these changes and don't like the company's prospects. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we found 4 warning signs for Reditus Sociedade Gestora de Participações Sociais (3 make us uncomfortable) you should be aware of.

While Reditus Sociedade Gestora de Participações Sociais 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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