What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after we looked into Ricegrowers (ASX:SGLLV), the trends above didn't look too great.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Ricegrowers is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.067 = AU$36m ÷ (AU$739m - AU$208m) (Based on the trailing twelve months to October 2020).
So, Ricegrowers has an ROCE of 6.7%. In absolute terms, that's a low return, but it's much better than the Food industry average of 5.2%.
Above you can see how the current ROCE for Ricegrowers 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 Ricegrowers' ROCE Trend?
In terms of Ricegrowers' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 18%, 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Ricegrowers to turn into a multi-bagger.
On a related note, Ricegrowers has decreased its current liabilities to 28% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On Ricegrowers' ROCE
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 116% 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.
Ricegrowers does have some risks though, and we've spotted 1 warning sign for Ricegrowers that you might be interested in.
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