Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. Having said that, after a brief look, BSA (ASX:BSA) we aren't filled with optimism, but let's investigate further.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for BSA, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = AU$8.3m ÷ (AU$147m - AU$99m) (Based on the trailing twelve months to June 2020).
So, BSA has an ROCE of 17%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Commercial Services industry average of 14%.
Above you can see how the current ROCE for BSA compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From BSA's ROCE Trend?
There is reason to be cautious about BSA, given the returns are trending downwards. About five years ago, returns on capital were 22%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on BSA becoming one if things continue as they have.On a side note, BSA's current liabilities are still rather high at 67% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
In summary, it's unfortunate that BSA is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 86% return over the last five years, so investors appear very optimistic. Regardless, we don't feel to comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you'd like to know about the risks facing BSA, we've discovered 3 warning signs that you should be aware of.
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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