Ralph Lauren (NYSE: RL) will want to reverse his comeback trends
If you are looking for a multi-bagger, there are a few things to look out for. Among other things, we’ll want to see two things; first, a growth return on capital employed (ROCE) and on the other hand, an expansion of the company amount capital employed. This shows us that it is a compounding machine, capable of continually reinvesting its profits into the business and generating higher returns. However, after investigating Ralph lauren (NYSE: RL), we don’t think current trends fit the mold of a multi-bagger.
What is Return on Capital Employed (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. Analysts use this formula to calculate it for Ralph Lauren:
Return on capital employed = Earnings before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.017 = 109 million USD ÷ (8.2 billion USD – 1.7 billion USD) (Based on the last twelve months up to December 2020).
So, Ralph Lauren has a ROCE of 1.7%. In absolute terms, this is a low return and also underperforming the luxury industry average by 16%.
In the graph above, we measured Ralph Lauren’s past ROCE against its past performance, but the future is arguably more important. If you’d like to see what analysts are forecasting for the future, you should check out our free report for Ralph Lauren.
What the ROCE trend can tell us
When we looked at the ROCE trend at Ralph Lauren, we didn’t gain much trust. Over the past five years, return on capital has fallen to 1.7% from 16% five years ago. Considering that the company is employing more capital as revenues have declined, this is a bit of a concern. This could mean that the company loses its competitive advantage or its market share, because if more money is invested in companies, it actually produces a lower return – “less bang for the buck” per se.
The bottom line
Based on the above analysis, we find it rather worrying that Ralph Lauren’s return on capital and sales have fallen, despite the company employing more capital than five years ago. Yet despite these worrisome fundamentals, the stock has performed well with a 61% return over the past five years, so investors appear very bullish. Either way, the current underlying trends do not bode well for long term performance, so unless they reverse we would start looking elsewhere.
Ralph Lauren does come with risks though, we have found 2 warning signs in our investment analysis, and 1 of these makes us a little uncomfortable …
If you want to look for strong businesses with significant income, check out this free list of companies with good balance sheets and impressive returns on equity.
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