RH's (NYSE:RH) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Although, when we looked at RH (NYSE:RH), it didn't seem to tick all of these boxes.

Understanding 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. Analysts use this formula to calculate it for RH:

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

0.10 = US$340m ÷ (US$4.2b - US$936m) (Based on the trailing twelve months to May 2024).

So, RH has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Specialty Retail industry average of 13%.

Check out our latest analysis for RH

Above you can see how the current ROCE for RH compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for RH .

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at RH, we didn't gain much confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 10%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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, RH has done well to pay down its current liabilities to 22% of total assets. That could partly explain why the ROCE has dropped. 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

In summary, we're somewhat concerned by RH's diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 91% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to know some of the risks facing RH we've found 3 warning signs (2 can't be ignored!) that you should be aware of before investing here.

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

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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.