Reliance Worldwide (ASX:RWC) Could Be Struggling To Allocate Capital
What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 Reliance Worldwide (ASX:RWC), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Reliance Worldwide is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$212m ÷ (US$2.1b - US$201m) (Based on the trailing twelve months to June 2022).
So, Reliance Worldwide has an ROCE of 11%. By itself that's a normal return on capital and it's in line with the industry's average returns of 11%.
View our latest analysis for Reliance Worldwide
In the above chart we have measured Reliance Worldwide'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 Reliance Worldwide here for free.
What The Trend Of ROCE Can Tell Us
Unfortunately, the trend isn't great with ROCE falling from 21% five years ago, while capital employed has grown 409%. Usually this isn't ideal, but given Reliance Worldwide conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Reliance Worldwide might not have received a full period of earnings contribution from it. Additionally, we found that Reliance Worldwide's most recent EBIT figure is around the same as the prior year, so we'd attribute the drop in ROCE mostly to the capital raise.
On a side note, Reliance Worldwide has done well to pay down its current liabilities to 9.6% 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.
The Bottom Line On Reliance Worldwide's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Reliance Worldwide. However, total returns to shareholders over the last five years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
If you'd like to know more about Reliance Worldwide, we've spotted 2 warning signs, and 1 of them is a bit unpleasant.
While Reliance Worldwide 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.
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