Should We Be Excited About The Trends Of Returns At RGC Resources (NASDAQ:RGCO)?

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. Having said that, from a first glance at RGC Resources (NASDAQ:RGCO) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is 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. The formula for this calculation on RGC Resources is:

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

0.049 = US$13m ÷ (US$294m - US$23m) (Based on the trailing twelve months to December 2020).

Thus, RGC Resources has an ROCE of 4.9%. In absolute terms, that's a low return but it's around the Gas Utilities industry average of 5.5%.

Check out our latest analysis for RGC Resources

Above you can see how the current ROCE for RGC Resources 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 report on analyst forecasts for the company.

What Can We Tell From RGC Resources' ROCE Trend?

When we looked at the ROCE trend at RGC Resources, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.9% from 7.9% 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, RGC Resources has decreased its current liabilities to 7.7% 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by RGC Resources' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 85% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a final note, we've found 1 warning sign for RGC Resources that we think you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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