Returns On Capital Signal Tricky Times Ahead For RH (NYSE:RH)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after briefly looking over the numbers, we don't think RH (NYSE:RH) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for RH, this is the formula:

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

0.078 = US$261m ÷ (US$4.4b - US$1.0b) (Based on the trailing twelve months to August 2024).

So, RH has an ROCE of 7.8%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 13%.

See our latest analysis for RH

In the above chart we have measured RH'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 RH for free.

So How Is RH's ROCE Trending?

On the surface, the trend of ROCE at RH doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.8% from 23% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, RH has decreased its current liabilities to 23% 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.

Our Take On RH's ROCE

To conclude, we've found that RH is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 62% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

RH does have some risks, we noticed 5 warning signs (and 2 which don't sit too well with us) we think you should know about.

While RH may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.