Vita Group (ASX:VTG) Might Be Having Difficulty Using Its Capital Effectively
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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Vita Group (ASX:VTG), 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 Vita Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = AU$35m ÷ (AU$280m - AU$97m) (Based on the trailing twelve months to December 2020).
Thus, Vita Group has an ROCE of 19%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Specialty Retail industry average of 20%.
View our latest analysis for Vita Group
In the above chart we have measured Vita Group'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 Vita Group here for free.
What Does the ROCE Trend For Vita Group Tell Us?
In terms of Vita Group's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 19% from 55% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a side note, Vita Group has done well to pay down its current liabilities to 34% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 Vita Group's ROCE
In summary, we're somewhat concerned by Vita Group's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 69% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
One more thing, we've spotted 2 warning signs facing Vita Group 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. 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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