Capital Allocation Trends At Vital Farms (NASDAQ:VITL) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Vital Farms (NASDAQ:VITL), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

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. To calculate this metric for Vital Farms, this is the formula:

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

0.05 = US$7.7m ÷ (US$182m - US$27m) (Based on the trailing twelve months to June 2021).

Thus, Vital Farms has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Food industry average of 9.6%.

Check out our latest analysis for Vital Farms

Above you can see how the current ROCE for Vital Farms 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 Vital Farms.

What Can We Tell From Vital Farms' ROCE Trend?

When we looked at the ROCE trend at Vital Farms, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% over the last two years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Vital Farms has done well to pay down its current liabilities to 15% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Vital Farms' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Vital Farms is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 54% over the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you want to know some of the risks facing Vital Farms we've found 3 warning signs (1 is concerning!) that you should be aware of before investing here.

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.
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