RLX Technology (NYSE:RLX) Could Be Struggling To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at RLX Technology (NYSE:RLX) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for RLX Technology, this is the formula:

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

0.0043 = CN¥67m ÷ (CN¥16b - CN¥484m) (Based on the trailing twelve months to March 2023).

So, RLX Technology has an ROCE of 0.4%. Ultimately, that's a low return and it under-performs the Tobacco industry average of 17%.

See our latest analysis for RLX Technology

Above you can see how the current ROCE for RLX Technology 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 RLX Technology.

So How Is RLX Technology's ROCE Trending?

On the surface, the trend of ROCE at RLX Technology doesn't inspire confidence. To be more specific, ROCE has fallen from 7.4% over the last four years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, RLX Technology has done well to pay down its current liabilities to 3.0% 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.

Our Take On RLX Technology's ROCE

In summary, we're somewhat concerned by RLX Technology's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 19% over the last year, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

RLX Technology does have some risks though, and we've spotted 1 warning sign for RLX Technology that you might be interested in.

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.