Should You Be Impressed By ReTo Eco-Solutions' (NASDAQ:RETO) Returns on Capital?

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think ReTo Eco-Solutions (NASDAQ:RETO) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for ReTo Eco-Solutions:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.022 = US$1.3m ÷ (US$83m - US$25m) (Based on the trailing twelve months to June 2019).

So, ReTo Eco-Solutions has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Basic Materials industry average of 9.3%.

Check out our latest analysis for ReTo Eco-Solutions

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how ReTo Eco-Solutions has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at ReTo Eco-Solutions, we didn't gain much confidence. To be more specific, ROCE has fallen from 9.2% over the last four years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, ReTo Eco-Solutions has done well to pay down its current liabilities to 30% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by ReTo Eco-Solutions' reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 52% in the last year. Therefore based on the analysis done in this article, we don't think ReTo Eco-Solutions has the makings of a multi-bagger.

One more thing: We've identified 4 warning signs with ReTo Eco-Solutions (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.

While ReTo Eco-Solutions may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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