Beware of RGC Resources (NASDAQ: RGCO) and its Returns on Capital

If you’re not sure where to start when looking for the next multi-bagger, there are a few key trends you should watch out for. Typically, we will want to notice a growth trend come back on capital employed (ROCE) and at the same time, a base capital employed. Basically, this means that a business has profitable initiatives that it can continue to reinvest in, which is a hallmark of a blending machine. In light of this, when we looked RMC Resources (NASDAQ: RGCO) and its ROCE trend, we weren’t exactly thrilled.

What is return on capital employed (ROCE)?

For those unaware, ROCE is a measure of a company’s annual pre-tax profit (yield), relative to the capital employed in the business. Analysts use this formula to calculate it for RGC resources:

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

0.057 = $16 million ÷ ($299 million – $21 million) (Based on the last twelve months to June 2022).

Therefore, RGC Resources posted a ROCE of 5.7%. That’s a low number on its own, but it’s around the 5.4% average generated by the gas utility industry.

NasdaqGM: RGCO Return on Capital Employed September 8, 2022

Above, you can see how RGC Resources’ current ROCE compares to its past returns on capital, but you can’t tell much about the past. If you’re interested, you can check out analyst forecasts in our free analyst forecast report for the company.

What the ROCE trend can tell us

On the surface, the ROCE trend at RGC Resources does not inspire confidence. About five years ago, the return on capital was 7.3%, but since then it has fallen to 5.7%. Although, given that revenue and the amount of assets used in the business have increased, it could suggest that the business is investing in growth and that the additional capital has resulted in a short-term reduction in ROCE. And if the capital increase generates additional returns, the company, and therefore the shareholders, will benefit in the long term.

The essential

In summary, despite lower short-term returns, we are encouraged to see that RGC Resources is reinvesting for growth and has thus increased sales. These growth trends have not led to returns to growth, however, as the stock has fallen 12% over the past five years. So we think it would be worth taking a closer look at this stock as the trends look encouraging.

Since virtually every business faces risks, it’s worth knowing about them, and we’ve spotted 4 warning signs for RGC Resources (including 3 not to be overlooked!) that you should know.

If you want to look for strong companies with excellent earnings, check out this free list of companies with strong balance sheets and impressive returns on equity.

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