When we research a business, sometimes it is difficult to find the warning signs, but there are financial metrics that can help spot problems early. When we see a drop to recover on capital employed (ROCE) in connection with a decrease based capital employed is often how a mature business shows signs of aging. This combination can tell you that the business not only invests less, but earns less on what it invests. So after considering Renault (EPA: RNO), the above trends didn’t look too big.
What is Return on Employee Capital (ROCE)?
Just to clarify if you’re not sure, ROCE is a measure of the pre-tax income (as a percentage) that a business earns on the capital invested in its business. The formula for this calculation on Renault is:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.034 = € 1.5bn ÷ (€ 113bn – € 68bn) (Based on the last twelve months up to June 2021).
So, Renault posted a ROCE of 3.4%. At the end of the day, that’s a low yield and it’s 10% below the auto industry average.
See our latest analysis for Renault
Above you can see how Renault’s current ROCE compares to its previous returns on capital, but there is little you can say about the past. If you are interested, you can view analyst forecasts in our free analyst forecast report for the company.
How are the returns evolving?
We are a little worried about the evolution of returns on capital at Renault. To be more precise, ROCE was 7.1% five years ago, but since then it has dropped significantly. During this time, the capital employed in the company remained roughly stable over the period. This combination may be indicative of a mature company that still has areas to deploy capital, but the returns received are not as high potentially due to new competition or lower margins. So, because these trends are generally not conducive to building a multi-bagger, we won’t hold our breath to make Renault one if things continue as they did.
On a separate but related note, it’s important to know that Renault has a current liabilities to total assets ratio of 60%, which we consider to be quite high. What this actually means is that suppliers (or short-term creditors) fund a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally, we would like this to decrease as that would mean less risky bonds.
What we can learn from Renault’s ROCE
In summary, it is unfortunate that Renault generates lower returns from the same amount of capital. Long-term shareholders who held the stock for the past five years have experienced a 50% depreciation of their investment, so it seems the market doesn’t like these trends either. However, unless the underlying trends return to a more positive trajectory, we would consider looking elsewhere.
On a separate note, we have found 1 warning sign for Renault you will probably want to know more.
If you want to look for solid businesses with great income, check out this free list of companies with good balance sheets and impressive returns on equity.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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