Ricardo (LON:RCDO) Has Some Difficulty Using Its Capital Effectively
If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within Ricardo (LON:RCDO), we weren't too hopeful.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Ricardo, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.056 = UK£16m ÷ (UK£410m - UK£117m) (Based on the trailing twelve months to December 2022).
Thus, Ricardo has an ROCE of 5.6%. In absolute terms, that's a low return and it also under-performs the Professional Services industry average of 15%.
View our latest analysis for Ricardo
In the above chart we have measured Ricardo'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 Ricardo here for free.
So How Is Ricardo's ROCE Trending?
We are a bit worried about the trend of returns on capital at Ricardo. Unfortunately the returns on capital have diminished from the 15% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Ricardo becoming one if things continue as they have.
Our Take On Ricardo's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors haven't taken kindly to these developments, since the stock has declined 28% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
If you're still interested in Ricardo it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.
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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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.
