Returns On Capital At Reditus Sociedade Gestora de Participações Sociais (ELI:RED) Paint A Concerning Picture

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into Reditus Sociedade Gestora de Participações Sociais (ELI:RED), we weren't too upbeat about how things were going.

What is Return On Capital Employed (ROCE)?

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. To calculate this metric for Reditus Sociedade Gestora de Participações Sociais, this is the formula:

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).

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

View 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?

The trend of ROCE at Reditus Sociedade Gestora de Participações Sociais is showing some signs of weakness. Unfortunately, returns have declined substantially over the last five years to the 2.0% we see today. In addition to that, Reditus Sociedade Gestora de Participações Sociais is now employing 40% less capital than it was five years ago. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 53%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line

In summary, it's unfortunate that Reditus Sociedade Gestora de Participações Sociais is shrinking its capital base and also generating lower returns. We expect this has contributed to the stock plummeting 93% during the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Reditus Sociedade Gestora de Participações Sociais does have some risks, we noticed 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

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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