Roots (TSE:ROOT) Could Be Struggling To Allocate Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Roots (TSE:ROOT), we weren't too hopeful.

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

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

0.078 = CA$25m ÷ (CA$392m - CA$73m) (Based on the trailing twelve months to October 2022).

So, Roots has an ROCE of 7.8%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 16%.

View our latest analysis for Roots

Above you can see how the current ROCE for Roots compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Roots.

The Trend Of ROCE

There is reason to be cautious about Roots, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 10% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Roots becoming one if things continue as they have.

The Key Takeaway

In summary, it's unfortunate that Roots is generating lower returns from the same amount of capital. We expect this has contributed to the stock plummeting 74% during the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to continue researching Roots, you might be interested to know about the 2 warning signs that our analysis has discovered.

While Roots 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here