RCM Technologies (NASDAQ:RCMT) May Have Issues Allocating Its Capital
When researching a stock for investment, what can tell us that the company is in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after glancing at the trends within RCM Technologies (NASDAQ:RCMT), we weren't too hopeful.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for RCM Technologies, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$3.5m ÷ (US$65m - US$29m) (Based on the trailing twelve months to July 2021).
Thus, RCM Technologies has an ROCE of 10.0%. In absolute terms, that's a low return but it's around the Professional Services industry average of 11%.
View our latest analysis for RCM Technologies
Above you can see how the current ROCE for RCM Technologies compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering RCM Technologies here for free.
How Are Returns Trending?
The trend of ROCE at RCM Technologies is showing some signs of weakness. The company used to generate 15% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 29% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.
On a side note, RCM Technologies' current liabilities have increased over the last five years to 45% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
The Key Takeaway
To see RCM Technologies reducing the capital employed in the business in tandem with diminishing returns, is concerning. And long term shareholders have watched their investments stay flat over the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing, we've spotted 3 warning signs facing RCM Technologies that you might find interesting.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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