Reditus Sociedade Gestora de Participações Sociais' (ELI:RED) Returns On Capital Are Heading Higher

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Reditus Sociedade Gestora de Participações Sociais (ELI:RED) and its trend of ROCE, we really liked what we saw.

Understanding 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. 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)

0.018 = €1.2m ÷ (€161m - €97m) (Based on the trailing twelve months to June 2021).

Thus, Reditus Sociedade Gestora de Participações Sociais has an ROCE of 1.8%. Ultimately, that's a low return and it under-performs the IT industry average of 13%.

View our latest analysis for Reditus Sociedade Gestora de Participações Sociais

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 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.

How Are Returns Trending?

It's nice to see that ROCE is headed in the right direction, even if it is still relatively low. The data shows that returns on capital have increased by 88% over the trailing five years. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Interestingly, the business may be becoming more efficient because it's applying 52% less capital than it was five years ago. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 60% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

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

In a nutshell, we're pleased to see that Reditus Sociedade Gestora de Participações Sociais has been able to generate higher returns from less capital. However the stock is down a substantial 82% in the last five years so there could be other areas of the business hurting its prospects. Still, it's worth doing some further research to see if the trends will continue into the future.

One more thing: We've identified 3 warning signs with Reditus Sociedade Gestora de Participações Sociais (at least 2 which are significant) , and understanding them would certainly be useful.

While Reditus Sociedade Gestora de Participações Sociais may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.