When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Asbestos (CVE:AB.H), we weren't too upbeat about how things were going.
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. To calculate this metric for Asbestos, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0059 = CA$165k ÷ (CA$31m - CA$3.3m) (Based on the trailing twelve months to September 2022).
So, Asbestos has an ROCE of 0.6%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 2.5%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Asbestos' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Asbestos, check out these free graphs here.
So How Is Asbestos' ROCE Trending?
We are a bit worried about the trend of returns on capital at Asbestos. About five years ago, returns on capital were 1.9%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Asbestos to turn into a multi-bagger.
On a related note, Asbestos has decreased its current liabilities to 11% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Key Takeaway
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Since the stock has skyrocketed 145% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 6 warning signs for Asbestos (of which 5 make us uncomfortable!) that you should know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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