Ricardo (LON:RCDO) Is Reinvesting At Lower Rates Of Return
There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. However, after investigating Ricardo (LON:RCDO), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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. Analysts use this formula to calculate it for Ricardo:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.035 = UK£11m ÷ (UK£449m - UK£130m) (Based on the trailing twelve months to June 2023).
Thus, Ricardo has an ROCE of 3.5%. Ultimately, that's a low return and it under-performs the Professional Services industry average of 15%.
Check out our latest analysis for Ricardo
Above you can see how the current ROCE for Ricardo 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 Ricardo.
What Does the ROCE Trend For Ricardo Tell Us?
On the surface, the trend of ROCE at Ricardo doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 3.5%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
The Bottom Line On Ricardo'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 Ricardo. These growth trends haven't led to growth returns though, since the stock has fallen 19% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
On a final note, we've found 1 warning sign for Ricardo that we think you should be aware of.
While Ricardo 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.
