The Returns On Capital At Medifast (NYSE:MED) Don't Inspire Confidence

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. So while Medifast (NYSE:MED) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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. To calculate this metric for Medifast, this is the formula:

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

0.36 = US$81m ÷ (US$303m - US$77m) (Based on the trailing twelve months to March 2024).

Thus, Medifast has an ROCE of 36%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.

View our latest analysis for Medifast

In the above chart we have measured Medifast's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Medifast for free.

How Are Returns Trending?

When we looked at the ROCE trend at Medifast, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 59%. 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, Medifast has done well to pay down its current liabilities to 25% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Medifast have fallen, meanwhile the business is employing more capital than it was five years ago. This could explain why the stock has sunk a total of 77% in the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing: We've identified 2 warning signs with Medifast (at least 1 which shouldn't be ignored) , and understanding these would certainly be useful.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.