Ralph Lauren (NYSE:RL) Could Be At Risk Of Shrinking As A Company

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within Ralph Lauren (NYSE:RL), we weren't too hopeful.

Return On Capital Employed (ROCE): What Is It?

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 Ralph Lauren is:

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

0.11 = US$599m ÷ (US$7.0b - US$1.7b) (Based on the trailing twelve months to December 2022).

Thus, Ralph Lauren has an ROCE of 11%. In isolation, that's a pretty standard return but against the Luxury industry average of 16%, it's not as good.

See our latest analysis for Ralph Lauren

Above you can see how the current ROCE for Ralph Lauren compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Ralph Lauren.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at Ralph Lauren. About five years ago, returns on capital were 15%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Ralph Lauren to turn into a multi-bagger.

What We Can Learn From Ralph Lauren's ROCE

In summary, it's unfortunate that Ralph Lauren is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 18% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Ralph Lauren does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

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.

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

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.