Vital Farms' (NASDAQ:VITL) Returns On Capital Not Reflecting Well On The Business

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Vital Farms (NASDAQ:VITL) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for Vital Farms:

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

0.023 = US$3.5m ÷ (US$187m - US$32m) (Based on the trailing twelve months to September 2021).

So, Vital Farms has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Food industry average of 9.5%.

See 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, you can check out the forecasts from the analysts covering Vital Farms here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Vital Farms, we didn't gain much confidence. To be more specific, ROCE has fallen from 12% 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 related note, Vital Farms has decreased its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Vital Farms' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Vital Farms. However, despite the promising trends, the stock has fallen 27% over the last year, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a final note, we found 2 warning signs for Vital Farms (1 is a bit concerning) you should be aware of.

While Vital Farms isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.