Does Zicom Group's (ASX:ZGL) Returns On Capital Reflect Well On The Business?

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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. This indicates the company is producing less profit from its investments and its total assets are decreasing. In light of that, from a first glance at Zicom Group (ASX:ZGL), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Zicom Group:

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

0.013 = S$1.0m ÷ (S$145m - S$67m) (Based on the trailing twelve months to June 2020).

Thus, Zicom Group has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 11%.

Check out our latest analysis for Zicom Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zicom Group's ROCE against it's prior returns. If you'd like to look at how Zicom Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

The trend of ROCE at Zicom Group is showing some signs of weakness. The company used to generate 2.0% on its capital five years ago but it has since fallen noticeably. In addition to that, Zicom Group is now employing 20% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 46%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.3%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Key Takeaway

In summary, it's unfortunate that Zicom Group is shrinking its capital base and also generating lower returns. It should come as no surprise then that the stock has fallen 69% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Zicom Group does have some risks though, and we've spotted 3 warning signs for Zicom Group that you might be interested in.

While Zicom Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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